Good afternoon, and welcome to this conference call on the fourth quarter results. As usual, the call will take about an hour. Present today is our CEO, it's Alrik Danielson, our CFO, Christian Johansson, Pia Kjellberg, Head of Media Relations, and myself, Patrik. As usual, we will start with a presentation, and we will follow through with the question and answers towards the end. And as usual, again, I would like to ask you to try to limit your questions to one or two in order to make room for everyone in the Q&A session initially. With that, I leave the word to Alrik. Please, go ahead.
Thank you, Patrik, and good afternoon, and welcome to this conference call on the fourth quarter result. If we turn to the second page, key events in the fourth quarter, I would like to start with that. Our focus on developing our Rotating Equipment Performance offer continues with the development and launch of the next generation of Enlight centre Cloud-based data collection platform. It is designed to increase value in our rotating equipment performance agreements, increasing the efficiency in service delivery, and enabling on-time information and data exchange with customers on critical machinery. During the quarter, we also launched the SKF SimPro Expert, a new advanced simulation software tool that gives customers the power to develop applications, taking advantage of SKF bearing arrangements across a wide range of applications and services conditions. In the automotive business, we're making progress with the powertrain electrification area.
Our components have been selected by several automakers, including supplying bearings for the next generation electric powertrain platform of a leading European OEM. In the industrial side, we have finalized an agreement with the Croatian rolling stock producer, Končar, for the supply of bearings and axle boxes for its latest lower floor, electric and diesel electric multiple unit train. If we move to the next slide, another interesting example is the new multi-year agreement with ArcelorMittal, covering 14 of their steel mills across Europe and Northern Africa. Through a long-term process of documenting total cost of ownership savings, we've been able to illustrate the value of working with SKF, thereby securing long-term business for bearing units, seals, and remanufacturing services. If we turn to the next slide, continued organic growth.
Looking at the financial performance for the fourth quarter, we saw continued good growth and considerably improved operating margins. We've had a strong finish to 2017, a year characterized by strong demand in most markets. In the fourth quarter, net sales of SEK 19.5 billion grew organically by over 8%, with near double-digit growth in automotive. The improved sales volumes and factory utilization rates contributed to an adjusted operating profit of SEK 2.51 billion, SEK 350 million higher than last year, and adjusted operating margin of 10.7%, which is an improvement of 1.4 percentage points compared to last year.
During the quarter, we continued to see positive effects from the price increases we have implemented, and the sequential improvement trend that we have established over the last couple of quarters has continued in a positive way. The industrial business continued its positive development and delivered a significantly improved adjusted operating margin of 12.9%, driven by higher sales volume, improved factory utilization rates, and improved pricing. The automotive business delivered an adjusted operating margin of 5.9% in the quarter. Cash flow generation was strong in the quarter, and we continued to reduce our net debt by another SEK 1 billion, taking us well below our net debt to equity target of 80%. The board has decided to propose an unchanged dividend of SEK 5.5, which would equal to a direct return of about 2.8%.
Moving to the next slide, and our sales by market. Last year, we have grown both within industrial and automotive, and in all regions. When we look at the fourth quarter, organic sales rose by 9.1% in Europe, with strong sales to the heavy, special, and off-highway industries, industrial distribution, and to the energy, industrial, general industries, as well as the automotive industry. In North America, sales grew by 4.7%. By industry, we saw strong sales to the heavy, special, and off-highway industries, railway, industrial, general industries, and to the industrial distribution, while sales to the car and light trucks industries were relatively unchanged. In Asia, we experienced strong growth in most industries, except for energy, where we continue to see low volumes. In total, organic sales in Asia grew by 10% in the quarter.
Our organic sales in Latin America grew by 7.3% compared to the fourth quarter of last year, and we saw good growth in industrial distribution and automotive. In the Middle East and Africa, organic sales grew by 13.3% in the quarter. With those initial words, I leave it to you, Christian.
Thank you, Alrik, and good afternoon to all of you. So if you turn to the next page, sales development, I'll start there. We continue, as Alrik said, to experience a healthy growth in most of our markets and across most of our industries, both in industrial and automotive, with just a few exceptions. Organic sales increased by 8.2% in the quarter. Currency effects were negative, about 4% in the quarter, and the structure component was - 0.6, related to the divestment transaction that we closed in the second quarter. So in total, net sales increased with 4% in the quarter. If you turn to next page, we have the organic sales picture by quarter, which now is forming a bit of a plateau at about +8%, which we are very pleased with.
This is obviously a different pattern than the usual business cycle sinus curve that we used to see. The working days impact, as you might remember, was positive in the first quarter, with about 1.5% versus last year. It reversed with the same amount of days in the second quarter, and now the third and the fourth quarter, working days-wise, is about a half working day less than last year in each of the quarters. If you turn to the next page, adjusted operating profit, excluding items affecting comparability, was SEK 2,092 million, SEK 350 million higher than in the fourth quarter last year, as was mentioned. If you take the 12 months moving value, the full year, 2017, we the same measurement are at SEK 9.1 billion.
If you go to the next page, we come to the profit bridge, and I will spend some time on this. We have the quarter-over-quarter versus last year development, starting with items affecting comparability, which was SEK 72 million positive year-over-year, calculated in last year's exchange rates. We have items affecting comparability of SEK -75 million this year versus SEK 155 million last year. Restructuring costs this year was SEK 172 million, and we have this year a containment gain of SEK 163 million related to changed conditions in our pension plan in Germany. I will come back a little bit later with some more comments to that one. Remaining amount in the IAC relate to impairment.
Reelcraft that was divested in the second quarter contributed last year with SEK 21 million, which we obviously don't have this year, and the currency impact on operating profit was negative SEK 278 million in the quarter. Main effects coming from dollar and dollar-related currencies and the strengthening of the euro. We move to the operating performance. It is increased by SEK 658 million year-over-year. Contribution from organic sales increased by SEK 757 million, including the fixed cost contribution from manufacturing from increased production volumes. Price mix was positive compared to last year, and the improvement trend on pricing from previous quarters continues.
As you might remember from our last quarterly call, we commented that we were flat year over year in third quarter, and we would move into the positives in quarter four, and this we also did, although just a few tenths of a percentage. We do see a sequential improvement quarter by quarter on pricing, and we expect the slow but gradual improvements on price or price position to continue in the first quarter of 2018. With that, I'm moving to Unite. We had a high activity, if we look back in the fourth quarter of 2016, and we had a larger go live, as you might remember. The program continues.
However, compared to the fourth quarter of 2016, our costs in the fourth quarter now were SEK 150 million lower than last year. For the full year of 2017, the cash spend on Unite amounted to SEK 820 million, so about SEK 100 million less than in 2016. And the cost in the P&L, including amortization, around SEK 740 million in 2017 full year, about SEK 100 million higher than 2016. I think this is well in line with the guidance that we've given the full year.
If you look at Unite for 2018, we expect to have an activity level giving a lower cost, so positive P&L effect in the bridge, compared to 2017, about SEK 100 million on full year, of which SEK 50 million in the first quarter. Look at the cost development. We start material cost in the fourth quarter, came out in line with our expectations, and the total material cost was negative, about SEK 100 million versus the year before. And we continue to manage to compensate some of the raw material effects with positive effects from commercial activities, specification changes, and consumption. For the first quarter of 2018, we expect the material cost impact to be somewhat worse, about SEK 150 million negative year-over-year.
Raw material surcharges continue to increase, and we foresee somewhat less impact from the compensating activities in the startup of 2018. If you take the cost development besides material cost, we had quite a good quarter, I would say. We see salary inflation and extra cost in the upturn, coming. However, productivity and more positive outcome on quality-related costs and year-end reconciliations, has compensated here. We continue to have good cost control on our fixed costs, and if we take, we don't have that slide in the pack this time, but the fixed cost index in the quarter four, we're excluding Unite at SEK 100 million. So we have an unchanged cost level, since the end of 2014, measured in fixed exchange rates.
Headcount has increased somewhat in the quarter, however, staff positions are fewer than in the end of last year, despite the business upturn. Some comments then, finally, to the inventory development in the quarter. In fixed exchange rates, finished goods inventory increased in the quarter versus quarter three, with SEK 300 million. Last year, we kept our finished goods inventories flat in quarter four, which also was what we guided for this year. But I would say the increase is not due to lack of demand, rather that we based on the outlook, we continue to show a high service level to our customers. And our estimate for quarter one is that finished goods inventories will increase by about SEK 300 million. And last year, we had the same increase, SEK 300 million, between quarter four and the first quarter of 2017.
That was a lot of information, but I guess we can come back to that in the Q&A. So if we move to the next slide, some comments, by customer group then. Organic net sales within industrial increased by 7.7% in local currencies versus last year, significantly higher in Europe, higher in both Asia and North America, compared to last year. And the adjusted operating margin was 12.9%, compared to 10.1% in quarter four last year. Contributions from increased sales and manufacturing volumes, that also was very positive, and the price mix contributed positively compared to last year. We take the measurement on full year in industrial, we ended at 13.7%, up from 12.1% the year before.
We go to automotive. Organic sales in automotive grew by 9.6% in the quarter. Good sales growth, both from cars and light trucks, as well as for trucks. Strongest automotive markets continue to be in Asia. However, demand was also good in Europe. North America, sales were relatively unchanged compared to the year before. Operating performance has continued to strengthen in automotive, and the adjusted operating margin was 5.9% in fourth quarter, compared to 5.2% the year before, and for the full year, automotive ended the year at 7.2%, up from 6.5% in 2016. Some few comments to the P&L of the quarter, gross profit. Gross margin up 1.1% quarter-over-quarter, adjusted for one-timers. Gross margin improved 0.8% year-over-year.
S&A expenses decreased from 14% to 14.2% from 15.1. Same there, adjusted for items affecting comparability, we ended the quarter at 13.8% versus 14.6%, so 0.8% improvement. Financial net, relatively flat year-over-year, exchange rate fluctuations had somewhat more a negative impact this year than 2016. And then if you go to taxes, in the fourth quarter, we had a positive tax cost, so positive SEK 179 million, giving a positive tax rate of 10%. The quarter was then impacted positively by the U.S. tax reform that was decided at the end of last year by approximately SEK 770 million. I will comment that a little bit more on the next slide.
So finally, then net profit, basic earnings per share in the quarter, SEK 4.12 , positively impacted also on this tax comment that I just gave. And for the full year, basic earnings per share is SEK 12 versus SEK 8.75 earlier the year before. So if you turn to the tax slide here, just a few comments then. They decide the tax reform that reduced the federal income tax with about 14 percentage points. And if you include the state taxes, the corporate income tax in U.S. in 2018 for the SKF setup in U.S. will be around 25%, a reduction from 39%. So it's a 14% reduction.
The revaluation of deferred tax assets and liabilities in U.S. gave them a positive tax cost in the quarter of SEK 717 million and a negative effect in equity on other comprehensive income of around SEK 400 million. The U.S. tax reform will lower our tax in U.S. going forward with around SEK 10 million. If we consider this U.S. tax reform, also other changes in other countries like Argentina and France, that also have some tax reform changes here entering 2018, we expect our tax rate 2018 to be around 29%, versus the 30 we have guided for this year.
So next slide, cash flow after investments before financing, excluding M&A activities, was SEK 1.8 billion in the quarter, compared to just about SEK 1.5 billion the year before. Working capital decreased by around SEK 800 million in the quarter, while investments or versus last year, and investments were around SEK 40 million higher than the fourth quarter the year before. If we take the 12-month period on the same measurement, we are trending now on SEK 4.2 billion in cash flow. Net working capital on the next slide was 29% of sales at the end of the fourth quarter, so 1 percentage point lower than in the fourth quarter of 2016, and this was positively impacted by currency. We see good progress when it comes to trade payables.
As you see in the slide, receivables have improved to 17.2%, while inventories increased somewhat to 22%. As I mentioned before, we have consciously increased our inventory levels than seeing, how the outlooks, during the quarter here to keep, high availability and service levels for our customers. If you take the next slide, net debt, we continue to decrease our net debt, despite that we had an increase on the post-employment benefits, this quarter of around SEK 400 million. So despite that, we have a net decrease of close to SEK 1 billion. As you see on the ratios here, net debt equity is now at 71% and excluding pensions at around 30%.
So coming back then to the German pension plan, where we have agreed with all involved stakeholders to change conditions from January 1st, 2018, which means that our service cost for our pensions in Germany will be reduced. This will happen in steps in the years to come, and in 2018, the reduction will be about SEK 40 million effect. When it comes to the balance sheet, our pension liabilities in Germany, we will not see any effects in the short term, except for the containment gain that we talked about for quarter four. However, over time, as the population change into the new defined contribution plan, the pension debt will be reduced. So finally then, on the guidance for quarter one, we expect the financial net to about SEK 225 million negative in the quarter.
If we come to the currency effects, based on the exchange rate by end of December, the currency impact on operating profit is expected to be around negative SEK 300 million in the first quarter compared to first quarter last year. If you will take the snapshot here of the rates that we had, January 29, so early this week, the currency effect in the first quarter will be somewhat higher, so negative SEK 350 million.
So finally then, as for the full year, tax level at about 29%, as I said, and in line with what we have communicated when it comes to, investments, we guide that, property, plant, and equipment to be additions to plant and property about SEK 2.4 billion for the full year, up somewhat from the, as you see in the report, we came out in line with guidelines, SEK 2.2 billion this year, 2017. So with that, I turn over to you, Alrik.
Thank you, Christian, and we go to the next slide on the outlook. During 2017, we have seen a broad-based recovery in most markets, and we've grown by about 8% organically for the full year. Entering 2018, we expect to see continued growth in all major regions in the first quarter, as reflected in our new market outlook. Demand compared to the first quarter 2017, the demand for SKF products and services is expected to be higher for the group, including industrial and automotive. Demand compared to the fourth quarter 2017, the demand for SKF products and services is expected to be slightly higher for the group in industrial and higher for automotive.
Demand is expected to be higher in Europe, North America, and in Latin America, and lower in Asia. If we go to the next slide, and I will turn now over to Patrik for details. To wrap up.
Okay, thank you. Thank you, Alrik. Just a quick reminder here before we go into the Q&A session, about the upcoming events. Tonight and tomorrow, we hope to meet with some of you here in Stockholm. Next week, we will be traveling in the U.S., to New York and Boston. The next opportunity after that will be at some of the upcoming conferences during the spring. I hope to see you there, and with that, we move directly into Q&A. Operator, please.
Certainly. As a reminder, if you'd like to ask a question today, please press star one. We will now take our first question from Peder Frölén from Handelsbanken. Please go ahead. Your line is open.
Yes, thank you. Thank you, Alrik and Christian, Patrick. On the prices, I think you probably gave the information you want to give, but let's assume we are up, like, 30 bps or so sequentially, and I guess what you alluded to, that that pace will continue. My question is really, I hear out there that both you and some of your competitors increases prices quite significantly in the distribution market in North America. We're talking 5%-6%, which means then that this gradual, whatever bps it is, should be able to continue for quite some time. How should I think of the projection of the curve here? Are we seeing continued price component improvement, even after second half of 2018? Now I'm only talking about off the market or distribution prices.
You know, this is Alrik here. You know, like I think like we've consistently said throughout this since the recovery started, actually mid-2016, as we come now into a more bullish marketplace, there is a different dynamic. And as also you see a general understanding that prices will have to be adjusted also by our competitors, gives a momentum to this. And we still continue to say the same things we have said throughout this recovery. There is pricing power. There will be a possibility for us to offset the kind of cost increases we see, and with good work, recover margins.
And the thing that makes it take time is that, of course, in the OEM markets, where you have yearly contracts and sometimes bi-yearly contracts, you don't go in and break a contract with a customer. You sort of work with them, and as these contracts come to an end, you have the opportunity to renegotiate the prices. And we see the same dynamics today as we saw before.
I think, maybe additional to that, and you have heard us saying this before, but I think also we have delivered exactly what we have said. So if it's 0.3 or to 0.5, quarter by quarter here for a few quarters, so, that, that's, y ou know, it's difficult when you say, in the end of 2018, will that curve or trend change, but at least, you know, we guide that for what we can see in the short term, that will continue, huh?
Yeah. And respect for the one question then, in the mix here, is that significant? Since you talk about price/ mix is positive, so this mix negative or positive in the quarter, if you just, so do it separately.
I mean, mix, as you know, we have said, mix usually have a bigger impact than price. I mean, it swings. Obviously, you have. I don't want to comment it on the quarter, but, I mean, you have the automotive industrial mix, which in this case, for this quarter, is negative. Then you have, I mean, since inventory has been built up in the distribution channels over the quarters, you have now more of a OEM versus aftermarket mix, which then, I mean, underlying also is negative there, so. But, I mean, it is the component that's part of the bps we are talking about, obviously, yeah.
Yeah, that's very clear. Thank you for that. I get back in line.
We will now take our next question from Lars Brorson, from Barclays. Please go ahead. Your line is open.
Hi, thanks. Christian, just on the bridge, if I could just ask to the impact from inventory restocking in the quarter. I know it's a recurring question, but it's quite meaningful in Q3. I think we talked about SEK 100 million or so impact, year-over-year on your EBIT line. Could you help us with that in Q4? And can you just confirm, which I think you mentioned, that there will be no inventory build sequentially in Q1 versus what we saw last year, i.e., that it should be a neutral in this current quarter?
Now, I mean, if you take Q4, SEK 300 million on the fixed finished stock, obviously have some fixed cost contribution there. And as we've said, I mean, you have to have a view on that yourself then with a mix of automotive and industrial there. So that is a fixed cost contribution on the SEK 300 million that we have in quarter four. And you're right, we guide for SEK 300 million in Q1, which was also the inventory build that we had in Q1 2017. So there should not be any year-over-year inventory P&L effects there, if we are right in our guidance.
That's helpful. Secondly, if I can just ask Alrik on the, on the U.S. side. I had expected more of a recovery in, in automotive in Q4. Your car segment is flat year-over-year, VSM is, is down. That runs a little bit counter to what I think we talked about in October, with some, I thought, more temporary issues, particularly in the car side. Can you help us understand, where we are in terms of that business, and also what's embedded in your outlook for Q1? You're obviously flat year-over-year in North America for the group. I wonder how you see automotive within that?
I think we're doing well in automotive. If you look at, you remember, we talked about some changes in programs that were keeping us down. I expected this to come back a little bit quicker when we talked a quarter ago. Now, I see that maybe the recovery in the U.S. from a sales point of view is more flattish than I previously expected. But it has nothing to do with our relative position. I argue we are still in a strong position and growing above market.
So, the situation also, when you look at the—there were strong, very strong end of the year in VSM in the U.S. last year, and, and, and of course, in a comparison that was difficult to meet. So, from that point of view, how we are doing, I think we're doing fine in the US from that point of view. So it will depend. If we have a good, strong automotive quarter from a demand point of view, you will see that reflected in SKF figures, too.
And maybe then also in addition on the VSM side, Alrik, of course, is right with the reference quarter there that we had. It's also that if you look at, I mean, replacement market, and if you look at our product scope with bearings and seals, and if you remember, you know, this, I would say, the main period of replacement is when a vehicle is somewhere 8-12 years, and if you calculate backwards, you come to the years of the Lehman. And if you look at the population effects that you got those years, that impacts the aftermarket on automotive, somewhat. So, there also, I would say that we have. I mean, it's not the science, but that impacts certainly the VSM, somewhat weaker performance.
No, I understand. I understand that, and I appreciate the underlying market issues. I was more after the sort of company specifics. But maybe I can ask one final one before I let you guys go, and I'll go back in the queue. You're pointing to significantly higher margination in Q1. That's on a very tough comp. I think you grew organically 13% there. I was curious just to, Alrik, to get a little bit of color around that, particularly what you see in China, both on industrial distribution, but also some of the bigger OEM segments there as you go into 2018.
Yeah. I actually came back from China last week, and it's interesting. There's a very high level of confidence, I think, with most of our customers going forward in their both domestic business climate and also in the way they look at the world.
Anything specifically you can point to that's driving growth?
No, I mean t here's a lot of activity, there's a lot of upgrading of equipment, there's a lot of hard work to boost output, and in general, a lot of positive discussions.
All right. Thanks.
We will now take our next question from Markus Almerud from Kepler Cheuvreux. Please go ahead. Your line is open.
Hi, Markus Almerud from Kepler Cheuvreux. Can I start with just seeing that one of your peers is warning for bottlenecks going forward, and they need to keep an eye out for them. Are you seeing any bottlenecks, both in Europe and in the U.S., in your subsupply, in the value chain?
During this, this is Alrik here. During this upturn, there has been bottlenecks in the value chain as far as steel supplies, you know. Been, some of the steel industry has had to ramp up, and I think you are well aware of that. And of course, when you're ramping up hard, it can create bottlenecks in the industrial value chain. We think it's coming to become more and more normalized, but there are some product lines also for us that where supply is still tight.
Okay, but it's more-
We hope to be able to mitigate that to our customers stay happy, but that's one of the reasons that we see continued demand also in the value chain.
Okay, but it's more behind you rather than going forward. It's nothing that-
I would argue it's behind us than, than going forward. But there are still product groups, you know, it's not even, you know? There are some product groups where demand is surprising you a little bit. And of course, as the order book is very strong, sometimes, you know, you struggle when the product portfolio is very wide, et cetera. But I think these problems are more behind us than anything else.
Okay. Then if I can just ask a quick question about the dividends. If you can just, s o unchanged dividend despite better operating environment, good cash flow, improved balance sheets. What was the reasoning behind keeping the dividend unchanged?
I think, if you—we have a dividend policy there which says that about 50% of our net profit should be distributed. And,
Uh-huh.
If you take it now, you are at around 46%. So, we have been above the 50%. So I think we are well in line with the guidance that the board is working with when they take this decision.
And I also say, we have a good plans of continuing to grow and invest in our business, and, I'm sure that, as we continue to perform well, the shareholders that stay with us will find a good development also in this going forward.
Okay. And then just, just finally, if I can, just, just to going back on Lars' question about the inventory. So just a housekeeping. The SEK 300 million that you built in Q4, can you remind us what you built in Q4 last year? So what was the data? Did you build SEK 300 million sequentially as well in Q4 last year?
I'll see if I have that for you.
Just to get the year on year data.
Q4 2016. There's 2, 4 back in my list. We help you to get it afterwards. Do you remember that, Patrik?
Sorry, what we built in Q4 2016.
Versus Q3.
We were flat, flat last year, sequentially in the-
Okay. Okay.
Yeah.
Okay, so the delta was, the delta was also SEK 300 million. Perfect. Thank you very much.
Our next question comes from Andre Kukhnin from Credit Suisse. Please go ahead, your line is open.
Good afternoon, thanks for taking my questions. Firstly, on pricing, thank you for confirming the dynamics from the price increases that you implemented last year. But we're also hearing from the channels that there are plans of a further price increase from some of the bearings makers. Can you comment at all whether you are planning a further price increase during 2018?
You know, we always work on price increases as is normal in a situation like this. And I think I can just reiterate what we've been saying is, that there is pricing power. We're working diligently to do it. I think it's very positive to see that it's a general market trend now to do this. And we are absolutely clear on the fact that we will be able to have a good development also going forward. Just like we have been working hard and had a good positive development also during 2017. The reason it takes a little bit of time sometimes is because, of course, some of the contracts, et cetera, they are renegotiated, not always immediately.
It takes sometimes one year, it can take up to two years before you actually make a renegotiation. And this is making it a little bit slower than you would maybe expect if you don't know this. But I just say: we have pricing power, it is possible, we see a good development from the marketplace in this sense, and this reassures us that we will be able to continue in the path that we are on.
Thank you. On negotiations with the OEMs, I think from previous calls, you said that there will be an opportunity to renew at higher prices as the year turns. I guess now with being the first of February, could you comment on how these negotiations have gone so far this year?
Well, you know-
- broadly?
The ones that are, w e're in the end of January, so of course, the things that we're talking about now are in the making. But there's no difference. I think that I've been trying to say all along, there's no difference. There's a good dynamic in the marketplace. SKF is competitive. Other players are also increasing prices. There's nothing sort of to add, if you understand what I mean. This is we're in a positive market trend.
Okay, got it. Thank you. Can you still hear me?
Yes.
Great, thank you. Can I just ask another question on a much broader topic, on kind of cash generation versus capturing the growth opportunities and where priorities lie? Obviously, you've had quite a bounce in demand and have committed some cash to working capital or to inventory to capture that. But going forward, when do you expect to come back to kind of normal cash conversion situation? Because we see EBIT up SEK 500 million, but free cash down SEK 3 billion in 2017. And we see the 2017 Q4 up, but that's versus, I think, the weakest quarter in probably five years. Just wanted to see if it's 2018, or is it, you see that beyond that when you'll have cash catching up?
But I think, I mean, if you take it also on the broader, as we have discussed here, and the questions that we have got, I mean, on the growth and capture the growth, and we have been being on a 8% growth the full year. But do you have bottlenecks in the supply chain and so on? I think we have tried to maneuver this in a way also, and we have commented before that we have bought some steel in advance, where we have seen the bottlenecks are coming. We have, you know, double sourcing of steel in order to really to take the opportunity here when the market is growing here.
So obviously, we have prioritized that, and we have taken that conscious decisions. The answer on your question, whether it will be in Q1, Q2 2018 or how it looks, it's difficult to say. It depends on how the market goes, and also on these questions that you are, you're on the bottlenecks and so on. Because we are determined that we are going to see to that we grow share in this market. And that means we need to have availability and service level. In the interest environment we have now, we are judging that to be the right thing to do. So, but certainly when you don't have that market, then maybe when it start to soften, the priorities will turn, huh?
But even with a relatively good growth, we should be able to start working on these issues when the supply situation normalizes going forward.
Great. Thank you. And very last follow-up. On energy as a segment, looking at your pluses and minuses, that seem to have taken quite a sharp turn for the negative in North and Latin America, kind of from 2 or 3 pluses to 3 minuses. Could you comment on that? And what part of energy you're seeing that, and in context that Europe is, I think, holding up really well, is this renewables related?
Yeah. Well, there's a lot of, if you take Latin America, you can understand that that's what it's all about. We are very strong position in Latin America, as you understand. And during the fourth quarter, there were very few installations made actually in Latin America. So-
Right.
But as soon as it starts coming again, we will be back, huh?
North America, for me?
Well, North America is the same. There's been some negotiations maybe where we are not running to be, you know, if we don't get a fair value for the product, you know, maybe we haven't been chasing it as hard as we would have normally. But basically, it's gonna be a similar situation.
Got it. Thank you for your time.
We will now take our next question from Gael De Bray, Deutsche Bank. Please go ahead. Your line is open.
Oh, thanks very much. Good afternoon, everybody. Clearly, you've showed pretty strong growth in automotive this quarter. But, I mean, the question is, what's really driving the relatively disappointing incremental margin for that division, at least comparatively to industrial? And then perhaps also, still looking at automotive, to what extent do you think that the strong growth you've achieved in Q4 relates to the exceptional strong production figures that we saw in France last quarter? And what's the risk that this could actually retreat somewhat in the first quarter? Thank you.
Maybe I'll start on the first, and then eventually we have to ask you again, or we did not catch your automotive questions, right. But the first one, I think we had a very good leverage in this fourth quarter on the growth. I mean, profitability, depending on how you calculate it, the leverage on the sales volume is very good with industrial terms. So I think we get the leverage out on the volumes that we see, yeah?
Well, if I may, I think it is very strong in the Industrial division, but actually not so strong in Automotive.
I mean, I mean, relatively to the margins they have, I don't think it was a bad quarter for automotive either, huh? I think it's okay.
All right. So I think what...
I don't know if you look at the adjusted or if you look at the reported. If you look at the... But it, it's good. But I mean, you have a positive, if you take it on the report, the pension plan closure in Germany, it's more favorable if you look into, if you include the one-offs, more favorable to the industrial. But it's good. The adjusted one in automotive, I don't think it was a particularly weak somehow this quarter. And if you please, what do you mean by what happened in France?
The car production figures were extremely strong in the fourth quarter. I just wanted to know to what extent it helped you on the top line in Q4, and whether this is something that could be perceived as being really exceptional.
But of course, when there's a lot of cars produced and we are specifying to those platforms, we sell more product. And if there should be a turn, let's say, in the car production, and it should be different, it will, of course, affect us. What we argue is to say that we are good position with the car industry. We're strengthening our position, not only in Asia, and that is what is company specific.
So really, when perhaps in broader terms, talking about Europe, you don't see the good growth or the very strong growth you had in Q4 as being exceptional at all? That's not expected to-
It will depend on, you know, car demand in the quarter. You know how quickly when the, if there's a change in demand, there's gonna be a change in production. And if the production stays good, it's gonna be good for us, and if it increases, it's gonna be even better. And if it does not, well, it will be. But we foresee, as we have guided, in general, a continued demand, good demand.
Okay, thanks. Thanks very much.
Our next question comes from Ben Jimmy Uglow from Morgan Stanley. Please go ahead. Your line is open.
Oh, good afternoon. Thank you for taking my question. I'm sorry to labor the point on pricing. I know everybody's asking it every which way, but I wanted to make sure I really properly understood how you're thinking about this. You know, so basically, you see an ongoing improvement in price mix, which is good news. But you did call out in your opening remarks, quite a big step up in raw materials in 1Q. My question is: As we look forward into 2018, you are reasonably confident that your gross pricing will offset raw materials, so that by the time we get to the end of this year, your net pricing is effectively positive? So just-
Yes.
Okay, so, that trajectory should be better this year than last year, correct?
Well, you know, We are doing everything we can, that it, that it will be so. Yes, sir.
Okay, thank you.
You know, you put it very well. Can I quote you? It was excellent, the way you put it.
Well, thank you. Second question: the demand outlook in North America, sort of effectively stable, is that simply due to a tough one-two comp last year? Or is there anything that you're seeing in the industrial environment or the automotive environment that makes you a little bit more careful?
Well, we see maybe in the U.S., a flatter demand pattern. As we said before, we had expected it maybe to be even a little bit stronger in Q4, and we see a little bit flat in the automotive side. On the industrial side, well, you know, we think it's quite good demand going in. There's good underlying activity. Maybe there are some segments, you know, where demand could be lower in some certain segments, but in general, it's a very strong underlying demand in industrial. So, yeah.
That's very clear. Thank you very much.
We will now take our next question from Alok Katre from Société Générale. Please go ahead. Your line is open.
Hi, thanks for taking my question. Just to come back on the automotive point, just looking at the clean operating margin, you get to a drop-through rate of around 17% for the quarter. Now, obviously, given how strong the top line growth was, I would have thought it should have been a bit more. I'm just trying to sort of understand what's holding that back. Is it the mix, original equipment versus, let's say, the aftermarket? Is it just the net pricing and the negotiations that are going on with automotive customers, which are sort of holding this back? And so just thinking of how we should think about this, in 2018, as we go forward. Thanks.
No, I think you could say that -- I mean, we have obviously not reflected deep on this since we -- overall, we think automotive trends is absolutely in the right direction, and of course, the leverage in different quarters might vary. You could -- we could have some mix effect here by the fact that we have somewhat more OEM than VSM in this. But for the rest, y ou, you should see this, this comes in between the quarters, you know, but the trend, as we see it, is positive here. So we don't have any warnings on automotive.
We don't, by this, we don't say that your, t he way you look at it is, we think it's been a good drop-through in the automotive. And if you look at it, I think we're holding this well, and.
Yeah, should we sort of expect an acceleration in terms of drop-through as we head into 2018, as some of those contracts, like you said, start to get renegotiated? Or, you know, is it something that, let's say, currency or so on should hold it back? And given how strong trucks is, you know.
No, but you're right. Trucks—you're right, trucks is strong. We are well positioned in trucks, I would say, in all regions. We have an 8% target for automotive. We are striving towards that. We are guiding for positive automotive volumes also into Q1. If the drop-through is this or that in a quarter, I cannot comment on that. But I mean, the trend is positive, prices are discussed, and so on, the positive development on automotive should continue.
Okay. Okay, thank you.
Our next question comes from Daniel Cunliffe, from Liberum. Please go ahead. Your line is open.
Hello, thanks for taking the question. Just, a follow-up question on the cash flow and dividend. So the, obviously, dividend was flat this year, cash flow is improving, German pension eventually falling, discount rates, Germany, U.S., moving sharply, and you're at 71%, so you could assume that 2018 may fall into the 60s range. So, I guess the question is, on that flat dividend, are you trying to sort of send a message in terms of, you know, you need cash for working capital? As you see the growth coming through, how should we think about sort of M&A?
Because historically, once you fall into that sort of 60s net debt to equity, including pensions, level, you have seen, not just rising dividends, but actually, as you've seen in some of your Scandinavian peers, dividends, special dividends. So I just want to think about the message from that and how we should think about that as we move to 2018. Thank you.
You should firstly see that is, that our board and owners see that we give a good return on, on, in, by, by our organic growth and to continue to grow. So that's our main ambitions, and we have talked about what we do on, on, in our factories, technology upgrade, world-class investments, and our ambitions on to see to that we get a more efficient, tighter industrial footprint, and so on. So we have a very clear agenda on that, that the board is fully confident that we will continue to invest in, and that's also why we guide up on the investment side. So that's the main, the main driver of us going forward.
But of course, you know, this gives us a muscle to make to look at acquisitions in a different way. And you have to also see that, you know, dividend, once you take a decision to change the dividend, is you want to be absolutely sure that this is for long term, et cetera. And I think that there's the ones, the shareholders who stick with us, they will, in one way or the other, get the money, and hopefully by us performing better and better.
Okay. All right. Thank you.
Our next question comes from Klas Bergelind, from Citi. Please go ahead. Your line is open.
Yes. Hi, Christian and Alrik, it's Klas, Klas from Citi. Sorry, but I have to come back to price and mix. Here is my reasoning. Unite was a bigger positive than I thought, and you built inventories, which I didn't have, so that's two positives. The cost development was in line with my forecast, and the overall drop-through was in line with my forecast, some 40%. That suggests a rather flattish price mix, maybe up a bit, 20-30 basis points. Now, the comments I heard on auto stronger and more OEM sales, suggests to me that mix had to be quite a lot negative, but obviously, the positive is that pricing, perhaps up 70-80 basis points, which is a big step up. I just want to understand that, that relationship there.
I mean, you calculate, a lot there, I mean, obviously, but it's good to hear that our guidance and what comes out seems in your spreadsheets to fit together, huh? That's great. But what we can say, what we can say is that what we've said for a long time, there is a pricing momentum. You see how our competitors are also going in, and looking at it. It's a good demand in the marketplace. There's an increasing understanding from the customer base, you know, that raw materials have been going up, et cetera, and there's an understanding for that this needs to be, and should be offset. So there's a good positive momentum. That's true. That's true.
Okay, very good. Then when it comes to, last quarter, you said mix was neutral, distribution pricing was up 1%, OEM pricing was down by the same amount, so had a flattish price/ mix. Is OEM pricing still down by 1%, and we saw a big spike in distribution, or how is the relationship between the two?
I don't have a comment to that, Klas.
All right. My third and final one is on the inventory increase. You said flat finished goods inventory when we started the quarter. Demand is a bit better, but it's really driven by automotive. I just wonder why you had to hike production as you went through the quarter. Is it simply that you want to keep your delivery promise, building safety stock in a better price environment, just so you can believe—you can keep the delivery promise and ask for better pricing? So is it, it's a safety stock increase rather than just in for out.
No, but it's to meet our customers' expectations, our commitments to deliveries to customers. I mean, that's the main driver for us, huh? And when you're growing, you understand that when you're growing, you also have more goods in transit, more deliveries on the sea to reach the customer, et cetera, et cetera. And of course, when you have a strong demand situation, especially ramping up, if not to try to squeeze down inventories and optimize that, as opposed to actually betting on that the customer will continue to demand your products. There are some lead times, as you understand, in the value chain. We have thought that that was a better bet, and that's why we have not focused on driving down the inventory in the fourth quarter.
This money is still with us, so as soon as you get more normalized, let's say, less of a peak, you can start working on these things, and then we'll get the money back.
Yeah. So absolutely, it was just that the, the industrial side of the business was a bit weaker than I thought. And obviously, the industrial side carries most of the manufacturing relative to automotive.
Yeah.
That was my question.
There are thousands and tens and 20,000 different items sold all over the world, you know, from different factories, so-
Yep, yep, yep.
This is quite a complex operation. So-
Yeah.
Don't worry, you know, the money still is-
All good.
With us.
No, totally. One very, very quick final one, and that is on energy coming down lower in North and South America. We all know about wind weakness. But can we talk about pricing in the energy segment? This is typically a high margin for you there. I mean, you are one of the biggest suppliers. Should we be concerned about mix in OEM, within OEM, getting weaker as wind is falling?
No, I don't think you should worry about the mix. That's clear. No. However, you can understand that, for instance, it's not good when an industry that you serve is having sort of more difficult times as far as margins, that's not good, huh? And sometimes then, maybe they are pushed to do things which may make it so that you may be inclined sometimes not to take the business, because they are in a situation where they rather go for not so quality supplier. So it's more that kind of dynamics. You will not see a negative mix effect from this.
Thank you.
Would you like to take another question or close the call?
No, thank you. I think we are up for our dedicated hour here. So we thank you very much for listening in, and if you have any additional questions, you are, as always, happy to, well, I'm happy to take your calls after this call. With that, we say thank you.