Good day, welcome to the SKF Third Quarter Report 2018 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Patrik Stenberg. Please go ahead.
Thank you. Good afternoon, welcome to this conference call on the third quarter results. As usual, the conference call will take about an hour. We'll spend some 20, 30 minutes on the presentation, and after that, we're open to take your questions. Present today are our CEO and President, Alrik Danielson, our Senior Vice President and CFO, Christian Johansson, Carina Falkenback , Director of Group Controlling and Accounting, Tia Schjelberg, Press and Media Relations, and myself, Patrik Stenberg, Head of Investor Relations. With that short welcome, I will hand over to Alrik. Please.
Thank you very much, Patrik. Welcome to this conference, where we're going to talk about a record strong third quarter from SKF. The third quarter was a strong quarter with good sales growth, solid margins, and a strong cash flow. We saw continued growth in both our industrial and automotive businesses. Sales grew organically by 7%, and our operating profit was SEK 2.6 billion, and it is the highest operating profit reported in SKF for the third quarter. The operating margin was 12.2%. We have reduced our inventories during the quarter, as we announced already in the beginning of this year that we were going to do, and we had a very strong cash flow of SEK 1.6 billion. If we now turn to the next page, the industrial business continues its strong performance with an operating margin of 14% and organic growth of 9%.
We saw significantly higher sales volume in our three largest regions, Europe, North America, and Asia, during the quarter. If we now turn to the next page, I can talk about the automotive business that delivered an operating margin of 7%, and sales grew organically by 2%, despite a drop in European car sales, resulting from, as we know, the implementation of new test cycles, and a slowdown in truck sales in Asia. If we look at the next page, we can talk about our performance targets. As you know, we have five financial targets covering organic sales growth and operating margin in the income statement and net debt to equity, net working capital, and return on capital employed on the capital side. All targets are valid over a business cycle. We are currently making progress in all of them.
As in Q2, we met or exceeded the targets for gross margin, net debt, and return on capital employed. In the third quarter, we have reduced our inventories, and we are starting to make progress towards our target of net working capital. We are now at 29%. There's still a lot of hard work left before we can reach the 24.5% target, but we're on the way. We turn to the next page and talk about geographies. We can see that we had a continued growth in Europe with 6%. We saw strong industrial demand with significantly higher volumes in most industries. We're talking about industrial drives, railway, agriculture, food and beverage, marine, and aerospace. In total, automotive volumes were relatively unchanged in Q3. There were large differences.
We saw significantly higher volumes for trucks and slightly lower for cars, due to, as I said, the implementation of the new WLTP test cycle. Asia grew by 11% with industrial significantly higher demand in most customer industries. Industrial drives, energy, heavy industry, railway, industrial distribution was significantly higher. Automotive volumes were slightly higher than last year, with higher volumes for cars and the vehicle aftermarket, while we saw significantly lower volumes for truck sales. Organic sales grew by 8%, a strong 8% in North America. We saw significantly higher industrial demand. Its industrial drives in aerospace, energy, agriculture, food and beverage, railway distribution, industrial distribution, all are significantly higher. In the automotive space, volumes were higher with significantly higher volumes to both trucks and cars. In Latin America, volumes were relatively unchanged compared to last year, and this is valid for both our industrial and our automotive business.
If we now turn to the next page, we'll give you highlights of innovation. As you know, it's the only assurance against irrelevance going forward. I'm proud to give some examples of what we're working on. During the summer, we have entered into a development partnership for the industrialization of fiber optic sensing systems. Fiber optic sensing technology is an extremely exciting opportunity as it enables bearings to become process and quality control instruments. We have worked for some time to develop these sensors, and by taking this next step, we will be able to speed up the process of integrating these into customer applications. If you take the next step, we talk about new tapered roller thrust bearings that we're just launching for the oil and gas industry to continue to push the limits of technology, as you know.
To meet the demands of leading top drive manufacturers, we have developed a new generation of tapered roller thrust bearings. The first ones in this category to join the Explorer family of high-performance bearings products. With higher load ratings and bearing working life extended by up to 300%. The new bearings are ready for the next generation of larger, non-powerful top drives. They can also be used to optimize the reliability of existing designs. We are sure this is going to have impact. If you then move to you, this is all I had intended to say.
Thank you, Patrik, and good afternoon to all of you. I will take you through the details from top to bottom. If we turn to next page, I will start with sales. Net sales increased by 14.6% in the third quarter. We saw organic sales growth for the eighth quarter in a row. Strong growth in our industrial business in all three large regions and most customer industries. And our automotive business keeps growing despite some headwind in the quarter. Organic sales increased by 6.9%. Currency effect on sales was strongly positive in the quarter, 7.8%, with the largest effect coming from the euro, followed by the dollar and the Chinese renminbi. The structure component was almost none related to a smaller divestment transaction.
If you turn page, operating profit by quarter has shown a positive trend since the second half of 2016, and the operating profit in the third quarter was SEK 2.6 billion, some SEK 630 million higher than the third quarter last year. It is the highest operating profit SKF has reported in a third quarter in history, and it is also the third highest quarter itself, only beaten by quarter one and quarter two earlier this year. The 12-month moving value was SEK 10.2 billion by end of the third quarter, and it is the first time ever that SKF has been above SEK 10 billion in operating profit for a 12-month period. If you turn to next page, taking you through the operating profit bridge for the quarter, which as usual will take some time, so I ask for your patience here.
We had a small positive effect from a minor divestment which generated a loss of SEK 2 million last year. The currency impact was positive, SEK 161 million compared to last year, and as I commented on sales development, the single largest positive currency effect on sales is from the euro. Result-wise, however, I'm sure you know we have negative effect from the euro, which means that the strong euro impacts our operating model negatively and has done so in the quarter.
Our operational performance increased by SEK 469 million year-over-year, corresponding to a leverage of 36% on net sales. Contributions for organic sales and manufacturing volumes increased by SEK 816 million, including positive effects from sales volume, from price mix, and from fixed cost contribution from higher production volume. It also included a negative effect of about SEK 100 million. Due to that, we reduced our finished goods inventories in the quarter.
The improvement trend on pricing that we have seen in previous quarters continued and contributed clearly positive. Mix was also positive since our industrial business grew stronger than automotive and our distribution business was strong. Cost development in the quarter gave a negative effect of SEK 347 million year-over-year. The material cost increased by SEK 160 million versus last year, and the higher material cost is due to delays in cost-saving projects, a negative mix consumption effect, and to steel tariffs. Cost inflation was around SEK 275 million and included higher utility costs due to the warm summer. Remaining cost items sum up to positive SEK 88 million, and I will mention some of them. We had extra costs related to that we run production on higher capacity utilization. This we have talked about also in previous meetings.
This quarter, we also had the new import tariffs on bearings from China to U.S. that was introduced this summer and has increased our import costs. We also had costs related to implementation of industrial footprint projects and to R&D and IT developments. We had a gain on sale of assets in the quarter reported here in the bridge. Last year, as we talked about last call, we also had costs from a customer settlement within automotive of SEK 190 million, which not is repeated this year. If I just take some comments to the guidance on the bridge for quarter four. We expect to see a continued positive effect from price mix in quarter four with a similar year-over-year effect as in quarter three.
Inventories, we will continue to reduce our finished good stock, and we expect a negative year-over-year effect on operating profit of about SEK 120 million. On the cost side, material cost impact, we expect to remain at SEK 160 million. Steel tariffs will increase somewhat. Cost inflation will also remain on similar level as high energy costs will remain. We expect some additional increases from bearing import tariffs due to volume. The impact on footprint, R&D, and IT will remain also in quarter four as these are good and improve our efficiency and pricing power for the future.
Also last year in the fourth quarter, we had items affecting comparability of a net of negative SEK 75 million with restructuring costs offset by the gain when we closed our German pension plan. We forecast restructuring costs in quarter four this year of some SEK 75 million, so a neutral bridge effect. All in all, materials, cost inflation, and other costs would add up to some SEK 750 million in the bridge. That was a long one. If you turn to next page. Performance by customer group. Industrial organic net sales increased in industrial by 9.2%. Sales were significantly higher in all our three main regions, Europe, Asia, North America. Operating margin was 14.3% compared to 13.5% last year, and the contribution from increased sales and manufacturing volumes was positive, together with the clearly positive effects on price mix.
Organic sales in the automotive industry grew by 1.7% in the quarter. Sales in Europe, as you heard, were impacted by lower sales to cars and light trucks as these WLTP test cycles were introduced. Also, we saw lower sales on trucks in Asia. Operating margin was 6.8% compared to 3.9% last year. Last year in Automotive also included then the customer settlement cost of SEK 190 million, and beside that, Automotive profitability was impacted mainly by import tariffs and material costs as mentioned on the bridge slide. If you turn page. Income statement for the group. Good development on our operating margins. Quarter three, we saw 12.2%, increase of 1.7% versus last year. 12 months, we are at 12.1%. Gross margin, same level as last year. S&A expenses as a percentage of sales decreased 1% to 12.9%.
The financial net was SEK 253 million negative and impacted by the debt repurchase, which had a net financial effect of negative SEK 73 million, and this was communicated to you in a separate press release. Taxes in the quarter, a negative SEK 753 million, giving an effective tax rate of 32.1%, and this was impacted negatively by withholding tax on dividends. If we exclude this effect, tax rate was 27.8%. We have a very good trend on earnings per share. EPS increased by 46% in the quarter and was SEK 3.35. For the last 12 months, we are at SEK 15.5 versus about SEK 9.8 a year ago. If you turn page, cash flow. We had a strong cash flow in the quarter. Excluding acquisitions divestment, it was SEK 1.593 billion in the quarter compared to SEK 880 million last year.
Improved cash flow due to higher operating profits, positive working capital contributions mainly. On a 12 months period, we were at SEK 5.8 billion by end of quarter three. If you turn page, net working capital. We're at 29% of sales at the end of the quarter, so 0.4% lower than the third quarter last year, and this ratio is also negatively impacted by currency. We see good progress when it comes to inventories and trade receivables with sequential improvements on both. As we have communicated to you since the first quarter telephone conference in April, we are reducing our finished goods inventories still with good availability in order to keep our service levels to meet customer demand. If you turn page. In July, we announced the divestment of our linear actuation business. We are very pleased with the outcome of this transaction.
Total consideration is SEK 2.75 billion on a cash- and debt-free basis, and we expect this transaction to close at the end of the year. The linear actuation business contributed last year with sales of SEK 2 billion and had about 1,200 employees. If you turn page, net debt equity ratio still very strong, reduced further to 60% by end of the quarter, excluding pensions, further reduced to 25%, and by end of the quarter, the net debt was about SEK 20 billion, a reduction by more than SEK 11 billion since quarter one 2015. Next page. In September, we issued a new seven-year bond, EUR 300 million bond, in order to extend our maturity profile. It was well-received in the market, and the coupon rate for us was a record for SKF, record low of 1.25%.
We used the proceeds to repurchase parts of the outstanding bonds with maturities in 2019 and 2020 with higher coupon rates, as you can see on the slide. If you turn page. Finally, I come to the guidance for 2018. We expect the financial net to be about SEK 225 million negative. Based on exchange rates of the end of September, currency impact on the operating profit is expected to be relatively unchanged compared to last year. Based on the exchange rates of the other day, October 23, the effect would be about SEK 60 million positive. For the full year, we expect a tax rate of about 28%. As we have communicated to you before, we are increasing our investments in property, plant, and equipment.
For the full year, we now expect to see additions to plant and property of SEK 2.6 billion for the year. Previously, we had a guidance of SEK 2.4 billion. With that, back to you, Alrik.
Thank you, Christian. Just to summarize, can we turn to the next page? The third quarter was a strong quarter with good sales growth, selling margins, and strong cash flows. We saw continued growth in both our industrial and automotive businesses. We grew by 7%, and our operating profit was SEK 2.6 billion, the highest that we've had so far in the third quarter, an operating margin of 12.2% with a cash flow of SEK 1.6 billion. I think that summarizes well what has happened. We saw also that our industrial volumes were higher and slightly lower automotive volumes year-over-year, as we have explained previously why this, but still a growth. If we take next page, I say, just to read to you the SKF outlook for the sake of good order.
Demand compared to the fourth quarter 2017, as we have, the demand for SKF products and services is expected to be slightly higher for the group, including higher demand for industrial and slightly lower demand for automotive. Demand is expected to be significantly higher in North America, higher in Asia, relatively unchanged in Europe, and slightly higher in Latin America. With those words, I hand over back to you, Patrik.
Thank you, Alrik. Thank you for the presentation. Now we are ready to take questions. Operator, please.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, please press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll now take our first question from Klas Bergelind from Citi. Please go ahead, your line is now open.
Yes. Hi, Alrik and Christian. It's Klas from Citi. A couple of questions, please. First one is on China. It seems like China is growing above 11.2% in total Asia, and this is despite automotive slowing. You're guiding for higher demand in Asia year-over-year, which is still solid given that automotive is likely to see further weakness. It seems like you're pretty confident there on China, on the industrial side into the fourth quarter. Can you talk about what you're seeing in China in the beginning of the quarter and your reasoning on China when you set your guide here in the fourth quarter? I will start there.
I think what we see is, of course, what we say exactly. You put it very well. We see a continuous solid development on the industrial side. We see a certain weakness that has started in the Q3 and that continues into Q4, exactly that you say, that we see that the total will still be positive.
In terms of automotive, how much sequential weakness can we expect there? Hello?
What we see is basically what we've guided for. I have no additional sort of comments at this point. I understand that the uncertainty is maybe increasing, this is what we see.
Yeah. I guess I'm just curious about whether industrial is guided flat sequentially in Asia, then obviously, against that you will have automotive taking a big leg down. I was trying to understand roughly the magnitude, yeah.
Yeah.
All right. The bridge, Christian, raw materials are moving higher again and also wages, then you have tariff costs. Are you including the tariff costs in the raw materials, or is that outside, how much was it? Could you help us with the wage bill in the quarter and how it developed in the first half as a reminder, just so we can understand the delta?
Tariffs, you can say you have two types of tariffs. First you have tariffs on steel. Steel imports to U.S., that's part of material. That's one of the explanations why we are at SEK 160. When you're talking about tariffs on importing products from China to U.S., that is not in material, not in cost inflation, it's in other.
Okay. Got it. What is the clean raw materials bill then, or impact?
Sorry?
What was the clean raw materials impact?
As I said, the drivers behind that we are worse than the guidance that we gave is mainly not underlying raw material. It's the tariffs. It's also that, and that's difficult for us, we have SEK 7.5 billion of materials a quarter. The mix of products that gives the consumption and mix effect, that was negative in the quarter. We had also some delays in cost savings, and some of them comes back in quarter four, as I said. That's my comment to that.
Okay. The wage bill?
Yeah, the wage bill as such, obviously, which is part of the cost inflation, underlying cost inflation, I wouldn't say that. Obviously, we have some variable salary schemes that are getting better outcome, let's say, when we do well, but the underlying wage inflation is not changing significantly.
All right. Moving on to price mix, I get this to 2.3% solid, you're managing to compensate, obviously, for the cost hikes in the quarter, you're up against tougher comps year-over-year as the price mix turned positive in the fourth quarter. Now you're saying that year-over-year, we will be similar in the fourth. Is that just OEM contracts are gradually coming through at higher price points, or are you hiking spot prices again? Just to understand how pricing will move sequentially.
You said 2.3. We didn't say 2.3.
I know.
I won't comment on that. As you see, we have a good development on price, and we have a good mix in it. The delta that we have in quarter three, we expect to see also in the fourth quarter.
Are you hiking again, or is it just OEM contracts coming through at high price points?
You have always a mix in a big structure like SKF's, a global business, huh?
There's no real difference in the way it's been playing out during the previous quarters-
All right
...this dynamic.
Thank you.
Thank you.
We will now take our next question from Andre Kukhnin from Credit Suisse. Please go ahead, your line is now open.
Good afternoon. Thanks so much for taking my questions. Christian, thanks very much for running through the details on the other line, on the cost line, the bridge component. Can I just double-check something? What was the bottom line that you gave for Q4 for the material cost inflation, other impact, et cetera, add up to, and then my line broke up.
750.
Sorry, SEK 750?
Yes.
Okay. That's SEK 160 materials and SEK 275 of cost inflation similar to Q3, the SEK 315 remaining, is that combination of Unite and restructuring?
I think I gave you quite some details or comments on that. As previous question, we have the import costs from China to U.S. on products get in there, as I said.
Right.
You said Unite, we do other things. I would say mainly other things on IT for the future. We have e-shop activities. We have other things, integrating the recent years acquired companies in our common systems to gain efficiency. We have also R&D step-ups that we've done during the year that are giving us a number of nice product launches in the time to come here.
Right. The reason I'm asking is that at SEK 315 is quite a lot on the bridge because as you said, you already had some restructuring of SEK 75 in Q4. If you have same restructuring, that's zero on the bridge. You had Unite already in the last year, presume there's no income. Basically, what you're saying is that it's the tariffs and other IT and R&D investments that are creating this extra SEK 300 something.
Yeah. We have SEK 19 billion of costs in a quarter.
Obviously when it comes to our ambition, not everything you invest in the future goes over the balance sheet. Obviously IT, R&D, and so on, these are good costs.
Right.
These are things obviously that we control ourselves also. These are conscious decisions that we are guiding for. Obviously if we have a business that can't carry this, we take other actions.
Got it. No, I appreciate that. As I said, I really appreciate detail. Just on the inventory impact, which you've clarified, how much did you reduce the finished goods inventory on like-for-like basis in Q3?
In line with guidance.
SEK 300 million?
Yes.
Okay. Thank you. Just last question, much broader one. I guess, Alrik, mostly for you. Just on the portfolio actions, you've obviously done quite a series of divestments, and have generated proceeds from that. You've been generating cash. What is your thinking on portfolio from here? Not really trying to step away from next quarter or even from just next 12 months, but more broadly, are you thinking about SKF on the three-year view from here as more bulked up through acquisitions, or is there more streamlining of portfolio to be done?
I think that you see that we now have an opportunity. We stand strong. We have taken over the years since I joined more than 11 billion SEK of strengthening our balance sheet and strong position, and we have an opportunity now to look for opportunities going forward, both how we can invest in our activities, in our factories, and in our R&D, as Christian has mentioned, but also look at acquisitions in a different way, of course.
Got it. Thank you very much.
We will now take our next question from James Moore from Redburn. Please go ahead. Your line is now open.
Yeah. Hi, everyone. Thanks for taking my questions. I have got three if I could. Maybe I could just start with the cost development line. Obviously, it conflates quite a lot of moving parts. But if we were to take out the raw material impact and the reversal of one-offs, could you talk a bit about the underlying cost inflation in the third quarter? I am primarily trying to understand the degree to which you have already had R&D, IT, and tariff ramp-ups in the third quarter, and how much you are signaling that they are incremental in the fourth versus the third, if that makes sense.
You get into such details that I am not sure I can give it to you. I comment a lot on the material development and the parts that brings us to the SEK 160. There, we are flat in Q4, seeing somewhat more steel tariffs because simply volume related. Somewhat more cost reduction on that line. I think the main driver on the cost inflation versus previous guidance is that energy prices are up. That is not unique to SKF, and that will remain as we see. We might consume somewhat more volume-wise, but that is the driver in that. I would say on the other costs, the sequential impact, you have a sequential negative impact on the import of product, as I said. For the rest, it is not a significant step up on that. Some, but not that much.
Okay. That is very helpful. Thank you. On pricing, I understand you do not want to give price mix, so I am not going to try and ask it directly, but maybe you would feel, and you said that the year-on-year impact is better than last quarter. Would you be able to quantify whether it is sort of 10 basis points better or 50 basis points better? I am a bit lost as to where we are since you stopped talking about it.
On pricing, we don't give that. You can calculate this. You get so much of details from us on the volumes and on the stock developments and so on. You have a receipt somewhere.
You can also see that in the marketplace, as I said before, there's no big changes of what became a similar kind of situation that we have delivered in the past.
Okay. Finally, if I could go back to China. When you look at your different end markets that you give at a global level, when you look at those in China, do you see some that are still growing sequentially, some that are flat, some that are down? A lot of companies are talking about deterioration in September versus July and August in general industrial in China and some concerns going into the fourth quarter. I just wonder whether you're seeing some big positives in some areas like wind or rail, for example, offsetting some underlying weakness in shorter cycle parts of that business. I wonder if you could peel the onion a little bit just to give us a flavor for what you're seeing.
Yeah. I think the guidance is pretty clear on what we're doing. Of course, there are always fluctuations between months, et cetera, in different businesses because of their dynamics. What we see is what we guide for. We're still positive on China the way we have, and Asia the way we have guided.
That wasn't really the question, if I could, and then I'll finish. Just sequentially, if you look at the last few months, has life come down a bit? I'm not talking year-over-year, which is your guidance and what you're talking about. Just in terms of running rates, are you seeing that step down or not?
You can understand that given the fact that we look quite positively on continuous sales into Q4, you can understand that it sort of continues.
Okay. Thank you very much.
Maybe I should add one more comment on the cost questions that you have asked. We have also in quarter three, year-over-year, the SEK 190 million from last year, on customer settlements in the bridge.
Yes, which will drop out in the bridge in the next quarter.
Yes.
Understood. Thanks.
We will now take our next question from Andrew Wilson from JPMorgan.
Hi, good afternoon, everyone. I just actually had a question again on capital allocation, but slightly from a different perspective. There's clearly been a lot of progress made on the cash profile, and Alrik, I think you've talked before about seeing a kind of a stronger sustainable cash flow at SKF going forward. Can you just talk about how you think about it in terms of share buybacks and the dividend and returns? Because I guess we haven't seen a lot of big M&A, and I'm not necessarily sure that's been a part of the strategy. Just thinking about how you think about M&A versus potential capital returns, because clearly we are in a significantly better position from the balance sheet than we were 12, 18 months ago.
Yeah. I think you said it very well. We have worked hard to focus our business and create a strong base for moving forward as far as investment in our business, in developing R&D and innovation, and also look at acquisitions. I wouldn't say that we are not looking at acquisitions. I think that's a clear part of our strategy going forward. You know what SKF has as a dividend policy, et cetera. I think you can expect good development in all of these areas going forward.
In terms of the potential for buybacks or for returns at some point if targets don't come along?
Yeah. In the end, it's going to be the owners who decide what we do with the money we have, if there's excess after we have made investments and acquisitions and so forth. SKF forte has always been a very strong cash flow, and I think this is one of the good things with SKF, and this is really positive. Sooner or later, either through higher returns or higher dividends, it will come back to the shareholders. I think SKF is a good bet for the future.
Thank you.
We will now take our next question from Matthew Spurr from Exane BNP Paribas.
Good afternoon. Thanks for taking the question. Just wanted to come back to tariffs and price mix. You talk about price mix being a similar level, presume you mean in terms of year-on-year improvement to Q3, but you've clearly got tariffs going up. When do you plan to offset the tariff impacts both on products and steel, and how long do you think that's going to take before you can basically recoup that, or do you expect to have to take that on the chin?
Well, tariffs are offset as we speak. I would say it's fully recovered when we enter into next year. You usually get some delays with the big OEMs, even though this is an obvious thing for them. It's compensated.
Right. Okay, thanks.
We will now take our next question from Andreas Koski from Nordea. Please go ahead. Your line is now open.
Yes. Thank you very much. I just have a question on the other operating income line. It was positive by SEK 141 million, and historically it's been around closer to zero. Could you just explain what's in that line in this quarter? Thank you very much.
Yeah. On that line we get some various currency effects on internal transactional flows, but we also have. We work with our footprint. We are selling assets and doing things around our footprint. This quarter we have a positive effect from, as I said in the comments to the bridge, our asset sale.
Can you quantify the asset sale? Sorry.
Can you quantify the asset sale?
It's the main part of what you see there.
Okay.
Some of the values.
That's enough.
Yes.
Thank you very much.
As a reminder, please press star one if you would like to ask a question. We'll now take our next question from Lars Brorson from Barclays. Please go ahead. Your line is now open.
Hey, thanks. A question just to follow up on your 315 tariff expected impact in Q4, or rather tariff most of it sounds like. Can you just elaborate on what assumptions that is based on? Do you assume a 25% tariff on items listed in the Section 301, level 3, or do you apply a different tariff rate on that just to get to the 315 number, please?
I wouldn't say that the 315 number, the majority is the tariffs. It's not. I don't know the section numbers, but the ones I refer to are the ones on imported products to U.S. from China.
Yeah, I know it is. I just wonder what tariff rate you have applied as your assumption to the 315 number.
Yeah, I don't have it in my head, Yeah, but it is the tariff that is applied to the bearings, which is the number that you mentioned.
The 25%?
Yeah. Yeah.
That's a net number. Do you have a gross number? How much are you offsetting with prices? I appreciate your point, Christian, that you expect to be fully recovered next year. I wonder what gives you the comfort of that.
There's a dynamic of increasing prices, of course, as you always do, and then there's a negotiation, as you understand. First you take mitigating actions to stock up before the actual tariffs come into place, and then you negotiate, as they come to the end of the year, we will have compensated everything. This is what we see, yeah.
How much are you redirecting sourcing out from China to other jurisdictions?
Of course, we're doing whatever we can to sort of see where there are capacities to reroute, et cetera. It takes a little bit longer to do that. Of course, we are.
Thank you.
Once again, that is star one if you wish to ask a question. We will now take our next question from Markus Mittermaier from UBS.
Hi. Good afternoon, everyone. Can I bubble up a little bit and sort of look at the different geographies and your guidance on underlying growth versus market share? What's sort of the dominating element in those two at the moment as you look at your different regions? If you could split it between auto and industrials, that would be very helpful.
Well, in a quarter in the bearing business, it doesn't go like that. The changes are slower than just thinking that you will have market share changes over a quarter. These are businesses that we have taken and orders that we have and the kind of sentiment we see in the marketplace, which is still positive.
No, I understand. At a higher level, is there any sort of material changes that you expect or that have happened on platforms in cars, for example?
Yeah. Well, you see.
I'm just trying to get it.
that we have discussed before. Remember that in the past, we were trailing a little bit behind during several years in the U.S. Now you see we have a strong growth in the U.S. It's, of course, that we have a good momentum in the OEM automotive market in the U.S., for instance.
So you-
as you see in our guidance.
Yeah. The positivity on China is largely underlying market. There's no sort of quarter-on-quarter change in sort of market share, or it's really underlying that you're.
It's not like that, no.
Okay. Thank you.
We will now take a follow-up question from Andre Kukhnin from Credit Suisse.
Oh, hi. Thanks so much for taking this follow-up. I just wanted to double-check on the tariff question. I guess what you're guiding for Q4 reflects the Section 301 list three, right?
I have a document here. It's the 301 and 232.
Okay. In the last one, I think that's 301, I think there's a structure there that sort of starts with 10% and then ratchets up to 25% tariff from 2019. What you said earlier about passing that through to the OEMs, do you think you'll be able to pass it through straight at 25 to the OEMs from beginning of 2019?
You know
How does that work?
Yeah. This is how we see it, this is the sort of the market dynamics that there is both a market that supports this and also a reality in the way it's discussed with customers that we can actually compensate this, yes.
Is there always a lag, or is this just the time to discuss this at the end of the year, and then from start of the year you'll get the whole thing offset?
Well, this is why otherwise it would have been binary, we would already have done it by today. It's a discussion and it's an understanding, we are doing our mitigating, having brought in materials a little bit ahead of the tariffs as well. The main thing that I think is interesting, if you look forward, is that we will compensate.
Okay. Got it. Thank you. Last one I had was just on the divestment that you made. Could you give us any idea on the profitability of that relative to the group? Is it kind of similar or higher, lower, so that we can get our models right?
Sorry, can you repeat that one more time, please?
It is about the divestment that you made. I just wondered if you could give us some idea of level of profitability of that business relative to-
Oh, well
...the group so that we can get the model right.
Yeah. It's in line with the SKF.
Got it. Got it. Thanks so much for your time.
Maybe then we have to stop that if it's not clear. On the tariffs.
Right
In the way the bridge is built, what we talk about on the cost is the cost. The compensation obviously comes in price mix, if that has not been clear.
No, that's clear. That's absolutely clear.
Very well.
Make sure we reflect that in the two sides. Thank you.
Thank you.
We will now take our next question from Erik Golrang from SEB.
Thank you. I have one question only. Obviously, the financial markets are a bit more concerned about what will happen to demand maybe going into 2019. I wanted to get an update on your cost structure now. I realize there's a lot of moving parts to this one, but if we assume that you disregard what happens to currencies and raw materials and so on, and sort of that you at some point will be taking mitigating actions, what would your leverage be on, let's say, a 10% negative organic growth next year or a single quarter?
No, that we don't have an answer to. I think if you look back, SKF has quite a good track record when it comes to work on cost. If you take the different pieces there, we should, of course, in your scenario, we should see steel prices and raw material prices coming down. When it comes to take care of our own productivity, I think we have different measures to do that, and obviously cost flex systems different in different countries when it comes to our factories. Obviously we have welfare time banks, we have different countries having systems where you share cost with the state and the employees and so on. Then, yes, you will see some restructuring, obviously, in such a scenario to a higher pace than what you've seen in the last year or so.
We have talked about that many times also, that what we do on the footprint in terms of consolidating our industrial footprint is not a short-term action, but it gives also effects when it comes to cost out.
We have been good at this, if you look. There's a good preparedness. We're prepared.
We know how to do this.
Overall, you'd expect to develop in a similar way as you've done historically?
We guide for the fourth quarter, as we've said, yes.
Okay. Thank you.
As a reminder, that is star one to ask a question. We will now take a follow-up question from James Moore from Redburn.
Thanks, everybody. Just a quick follow-up, if I could, on the SEK 138 million other income that was discussed earlier. That gain, is that booked in EBIT in one of the two divisions, or is it in the central line? Just trying to allocate it.
It's to the large part in Industrial.
Okay. Thank you very much.
We will now take a follow-up question from Lars Brorson from Barclays.
Hi. Thanks. Just to follow up on the tariff question, more with regards to your footprint in China that is selling into the U.S. Obviously a couple of acquisitions a few years ago, DBC, PEER as well, means you still have today a pretty sizable footprint, and selling out of China into the U.S. Can you remind me what that number is? How much of your U.S. sales is manufactured in China? Thanks.
We don't give that kind of detail. As you can see, it's manageable. It's relatively, on the total, a small amount.
Is that 5%?
You have my answer.
That's not very helpful, but okay. Thank you.
Thank you. I'm sorry.
There appears to be no further questions at this time.
Okay. Thank you so much for listening in to this conference call, with that, we conclude today's event. Thank you.
This concludes today's call. Thank you for your participation. You may now disconnect.