Good day, and welcome to the SKF Q2 Report 2017 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Patrik Stenberg, Head of Investor Relations. Please go ahead, sir.
Thank you, and good morning to all of you. Welcome to this conference call on the Q2 results. The call will take about an hour, as usual. Present here today are our President and CEO, Alrik Danielson, Christian Johansson, our CFO, also Karina Karlsson, who is the Director of Group Controlling and Accounting. Theo Kjellberg, heading up the Press and Media Relations, and myself, Patrik Stenberg of Investor Relations. As usual, we'll start by presenting the results, and after that, we will continue with Q&A. And with that, I leave the work to Alrik. Please go ahead.
Thank you, Patrik, and welcome. Good morning. Welcome to the conference call on the second quarter results, and I think we have a strong quarter with organic growth above 7%, 12% operating margin, and the automotive turnaround plan achieving the target of 8% operating margin for the first time. But before we dive into the figures, I want to talk about some of the highlights in the quarter. So let's go to the next page. We try to keep a high pace in the transforming our business. As you know, we work with our customer offering, with our investments, and also the structure of our company. In the second quarter, we launched a number of interesting offerings in our endeavor to drive digitalization.
We have launched a collaboration with Honeywell Process Solutions in a digitalization pilot project at a copper mine in Latin America, with the aim to create a digital standard for improved machine efficiency, reliability, and competitiveness of industrial customers. For rail, we have developed a wireless condition monitoring system inside the program of SKF Insight to enable condition-based maintenance practices that will help rail operators reduce their maintenance spend and improve reliability. It gathers bearing data and transmits it to remote diagnostic center for fast analysis of mechanical problems. It is a complete monitoring system for rotating equipment performance that enables maintenance extension. It interfaces with other systems for complete train monitoring. It is a small and low weight. It is fully wireless, no coach installation, and it installs quickly with a commissioning time of only two minutes.
If you look at the lower picture in the slide, you can see the small device there on the axle box to the upper left corner of the axle box. With the new SKF Insight Center for Marine, we present the most valuable information for defined user roles in a simple interface with one simple, single web login. We can provide all relevant information for a successful condition-based maintenance program. By doing so, we help the customer to improve maintenance work, enhance operational safety, and reduce downtime. The result is cost and time saving. We're also investing for the future in terms of our own capabilities in research and product development, as well as in modern and flexible production. I will briefly mention two reasons, examples.
We are investing in new production facilities for our automotive spare parts at the Saint-Sulpice site in France, in order to streamline the aftermarket activities for Europe, Middle East, and Africa. This is in a response to the changing market, market dynamics, seeing growing demands for flexible production capabilities that can cope with ever shorter lead times. In June, we inaugurated a newly built large-size bearing test center in Schweinfurt, Germany. It is the first in the world that is able to test large-size bearings in actual operating conditions. I will give you some more details around this investment on the next slide. We continue our activities in focusing on our core bearing business. With the divestment of Reelcraft completed in June, we have now raised approximately SEK 5 billion from a divestment in the last two years.
Christian will go through this in more detail in a couple of minutes. With that, we move to the next slide and show the Sven Wingquist Test Center. A few weeks ago, we inaugurated the Sven Wingquist Test Center for large-size bearings in Schweinfurt, Germany. The center is the first in the world that can test these large bearings with a diameter of up to six meters under dynamic loading conditions, simulating actual operating conditions, making customer development process faster and more reliable. This is just one example of how we are investing in the development of software and hardware that support our rotating equipment performance offer in key industries. Now, turning to the next slide and a brief introduction to the figures. Looking at the first financial performance for the second quarter, we saw continued good growth and improved operating margin.
Sales development was positive in all regions, and underlying industrial activity investments increased. Net sales at SEK 20.2 billion increased organically by 7.5% compared to the second quarter last year, with North America and Asia growing by double digits. The improved sales volumes and factory utilization rates contributed to an adjusted operating profit of above SEK 2.4 billion. This is an adjusted operating margin of 12%. The automotive business is developing in a solid manner, with a good, good operational improvement, delivering an adjusted operating margin of above 8%. The industrial business delivered an adjusted operating margin of 13.8%. Our underlying cash flow generation ability is robust at SEK 2.3 billion in the quarter. The divestment of Reelcraft contributed positively, of course, by just shy of SEK 900 million.
Turning to the next slide, just a brief recap of our financial targets. As you know, we have five financial targets covering organic sales growth and operating margin in the income statements, and net debt equity, net working capital, and return on capital employed on the capital side. These targets are all valid over a business cycle, and as you can see, we are currently making progress in all of them in relation to the last year's performance. On the next slide, you can see the trend, but I'll skip that and move directly to the slide after, and our sales development by region compared to last year. So if we move to the sales development by geography. The last six months, we have grown both within the industrial and the automotive in all regions.
In Europe, organic sales increased by 3.1% in the quarter. In Asia, we experienced strong growth in both automotive and industrial, and the total organic sales grew by 11.7% in the quarter. Our organic sales in North America grew 10% compared to the second quarter of last year, and we saw growth for both industrial and automotive. Organic sales in Latin America grew by almost 10%, and in the Middle East and Africa, the growth was above 13% in the quarter.
If we move to the next slide, and we talk a little bit about development by customer industry, you can see that sales to the automotive industry grew by 7.1% in the second quarter, and we saw good sales growth for both cars and trucks, especially in Asia, but also in Latin America and in Europe. In the U.S. we were growing again in trucks as well as in the aftermarkets. Sales with industrial, within industrial segment grew by 7.7% in the quarter compared with the second quarter last year. Sales to our industrial distributors were significantly higher, driven by strong volumes in North America, Europe, and Asia. Sales to the railway industry was significantly higher overall, especially strong in Asia. Sales to general industry was strong in Asia and North America, with significantly higher sales volume in the quarter.
The heavy and special and off-highway industries were all higher in the quarter, while sales to the aerospace industry was lower in all markets. With those remarks, I hand over to Christian.
Thank you, Alrik, and good morning to all of you. If we move to the next slide, sales development. Thank you. Total net sales increased with 10.4% in the second quarter. As already mentioned, we experienced a broad-based recovery in most markets and across most customer industries in both industrial and automotive. Organic sales increased by 7.5% in the quarter, and on the currency side, both the dollar and the dollar-related currencies, as well as the euro strengthened compared to the Swedish krona, and we had a positive currency effect in the quarter on 4.9% on sales.
The structure component, which in the second quarter was negative 2%, still relates to the two divestments that we did in the second quarter last year, and these two will not be reported as structure in quarterly onwards. We turn to the next page, the organic sales development by quarter, start now to form a typical business cycle sinus curve, and we are happy to see that the upturn pattern so far is stronger than the last upturn, as well as stronger than the downturn that we have come through. As you know, we had a first quarter with 1.5 working days more than in 2016, and now in the second quarter, we had 1.5 working days less.
As we discussed before, it's difficult to do a direct correlation between demand and working days. However, to some extent, the working day differences impact. Anyhow, according to the calendar, as it looks, we turn out in both quarters around 8% of sales growth. We turn to the next page, adjusted operating profit in the quarter, SEK 2.436 billion , some SEK 400 million higher than in the second quarter last year. The operating profit in the second quarter, including items affecting comparability of 121 million SEK, whereof 62 relate to restructuring activities, primarily of the manufacturing footprint in Americas and in Europe, that we have previously informed you about. Adjusted operating profit, excluding items affecting comparability for the last twelve months, was 8.3 billion SEK.
So on to the next page, we have the operating profit bridge, and if we start with the items that affect the comparability between the quarters, we had positive SEK 32 million year-over-year on items affecting comparability when we calculate in last year's exchange rates, and this mainly relates then to lower restructuring charges this year for cost reduction activities than what we had last year. Last year, two divested operations contributed last year with SEK 33 million in operating profit, which we obviously don't have this year, and the currency impact was SEK 156 million positive in the quarter compared to last year. If you move to the operational performance, that increased to an SEK 85 million year-over-year, starting with organic sales, including volume effects on fixed cost contribution in manufacturing, that was positively SEK 567 million in the quarter.
The positive contribution we had from increased organic sales and volume effect in manufacturing was partially offset by continued negative price mix. We started to see some positive effects from pricing activities in the later part of the second quarter, but overall, the price mix component in the quarter is still negative. However, slightly less negative compared to in quarter one. As we have mentioned before, we have launched our new SAP ERP system on January fourth, and our Unite program have had a high activity level after the go live, among other activities, to support the users in a new way of working. We had also less capitalization on Unite cost in the second quarter versus last year. But in total, we have SEK 60 million higher costs in the P&L compared to last year related to the Unite program.
For quarter three, we expect to have a cost level of Unite at the same level as we had in the third quarter last year. When it comes to cost development, second quarter was impacted by salary revisions. We also managed our, the upturn in our factories and in distribution centers to a large extent by temporaries and agency workers, which for sure is the right way to do it, but also a more costly way. On the other hand, our cost reduction activities on fixed cost side continues, and as you will see later in the presentation on when we come to headcount slide, we net reduced staff also in the second quarter with that 35-person, despite the upturn we are, we are in. On material cost side, the second quarter came out in line with expectations.
Raw material worsened with about SEK 100 million, and versus last year, we came out in total on material costs close to negative SEK 100 million. We continue to see positive effects from commercial activities, design and specification changes, as well as consumption, which compensate for the raw material increase. For the third quarter, we forecast a relatively stable or just slightly negative development sequentially on the material cost. Year-over-year, though, we had material cost improvements in the third quarter last year, so the gap of SEK 100 million from the second quarter will widen a little bit in the third quarter. But overall, on the cost side, we feel it's well under control. We turn to the next page, performance by customer group. On the industrial side, organic net sales increased by 7.7% in local currencies.
Sales were significantly higher in Asia, North America, and higher in Europe and in Latin America compared to last year. Adjusted operating margin of 13.8 compared to 12.7 due to last year, and, contribution we had from increased sales and volumes in manufacturing was very positive. However, then to some extent, offset by the continued negative price mix. We had also the effects of the last year's divestments, which both were part of the industrial side. Automotive organic sales grew by 7.1% in the second quarter. We saw good sales growth, both for cars and light trucks, as well as for trucks. The strongest automotive market continued to be Asia. However, we started as well to see good development in Latin America during the quarter.
Adjusted operating margin was 8.1% compared to 7.1% last year. Second quarter was a very good quarter for automotive on a broad base. They had strong deliveries, good manufacturing performance, some improvements in price mix. However, you might remember that we had some problems last year related to a warehouse change that impacted in North America, and that was especially impacting automotive negatively. So that obviously gives a positive contribution this year when we look at it year-over-year. If we turn to the next page, we have the P&L gross profit zero point seven percentage higher compared to second quarter last year, supported by increased fixed cost contribution and some slight improvements in price mix. Adjusted for one-timers or items affecting comparability, gross margin improved with 0.8%.
Selling and administrative expenses decreased from 14.1% to 13.7%. Financial net in the second quarter was SEK -258 million, was impacted by the bond repurchase of EUR 300 million that we did in May, and that impacted with about SEK -99 million, including effects from derivatives. On taxes in the second quarter, that was SEK -836 million, resulting in an effective tax rate of 40.7%. The taxes related to the Reelcraft divestment was SEK -279 million, and last year, we had tax costs related to the two divestments we did in last year, second quarter of SEK 386 million. So if we adjust for divestment in both years, tax rate was this year 27.2% compared to 34.2% last year.
On cost management, a few words more there. The fixed cost index in the second quarter was 101, versus our baseline at the end of 2014, and that includes the higher cost for the Unite program. Excluding the Unite impact, we are still below the baseline, we are at 99. And as earlier mentioned, we see effects from salary revisions at this time of the year, and obviously, our ambition is to stepwise compensate for this by continuing to work on productivity and optimizing our footprint and simplify our organization. When it comes to headcount, second quarter, number of employees adjusted for divestments increased by 732. Staff, as I mentioned, reduced by 35, workers increased by 75, and temporary and agency staff increased by 692.
So we are, despite the business upturn, still 2,900 permanent employees less than we were in end of 2014, adjusted for divestments. The next slide, we are at cash flow. We achieved a cash flow after investments before financing and excluding acquisitions, divestments of SEK 1.4 billion, and that was an increase of some SEK 250 million versus last year. Funds from operation increased by more than SEK 500 million, working capital increased slightly by SEK 300 million, and in these investments were some SEK 50 million less than the year before. Cash flow, adjusted for acquisitions and divestments for the last twelve months, is a solid SEK 4.8 billion.
If you turn to next page, the net working capital was 29.8% of sales at the end of the second quarter, about the same levels as the second quarter last year. In fixed currencies, net working capital was 0.6% higher than Q2 last year. We see good progress when it comes to trade variables. Receivables remain at the level above 18%, while inventories increased to 21.6%. And we have consciously increased our inventory levels in order to try to keep availability and service levels on an acceptable level for our customers in the aftermarket we now are in. I do expect that the inventories as a ratio to sale, will come down somewhat during the H2 of the year.
So if we change page, we are at the Reelcraft divestment that was divested to Madison Industries, and that was completed the last day of June. We are very pleased with this outcome of this transaction. If we look at the financial effects, we got proceeds of $892 million, and net of tax, we will have a cash flow effect of $613 million. As we've said, we received the $892 million by end of June, and taxes will be paid in the third and the fourth quarter. Should also maybe mention then as a guidance, last year, Reelcraft contributed with sales of about SEK 500 million and had an operating margin above the SKF Group average.
Turn page, we are at net debt, that increased about SEK 1 billion in the quarter, but as you know, we have paid the annual dividend of SEK 2.5 billion, and, that has provided our shareholders a direct return of about 3.2%, based on the share price at the end of June. Net debt equity is at 86% by end of second quarter. We turn page. Just want to mention also that we have done a couple of, transactions related to our debt structure. As mentioned, we repurchased EUR 300 million of our 2020 bond. The purpose was to reduce our refinancing risk and also to use our cash position in the most efficient way.
The bond, the bond, is fully swapped to dollars, and which means that we closed the currency swaps corresponding to EUR 300 million at the time of the repurchase. We have also, during the spring, repurchased a loan of SEK 1 billion, and we have taken a new dollar loans of $100 million into to with maturity 2027. This in total increased the duration of our debt from 3.6 to 4 years, and I would say we are pleased with the debt structure as it is now. Take the next slide. We are at the guidance, so some words to the Q3 guidance.
We expect the finance net of about SEK -200 million in the quarter, and based on the exchange rate by end of June, currency impact on operating profit is expected to be neutral compared to third quarter last year. And if we take a look at the most recent exchange rates, I think we have the Wednesday rates, we will be slightly negative, about SEK -40 million, if they remain. We expect a tax level of about 30%, excluding effects from divestments, and we have additions to property, plant, and equipment, same guidance as previously, SEK 2.2 billion additions for the full year, 2017. With that, Alrik, back to you.
Thank you. On the demand outlook for the third quarter 2017, since the beginning of the year, we have seen a broad-based recovery in most markets, and we grew by 7.5%, as I've mentioned, organically in the second quarter. Entering the third quarter, we expect to see continued growth in all major regions, as reflected in our new volume outlook. Demand compared to the third quarter 2016, the demand for SKF products and services is expected to be higher for the group, including industrial and automotive. Demand is expected to be higher in Europe, North America, and in Asia, and significantly higher in Latin America.
Demand compared to the second quarter 2017, and the demand for SKF products and services is expected to be lower for the group, and industrial, and slightly lower for automotive. Demand is expected to be significantly lower in Europe, and relatively unchanged in North America, Asia, and in Latin America. Next slide, please. Well, you know, as, with the, this inspiring picture here from, Gothia Cup, and, you know, right now, as we take one of the, things that, and that, I think is fantastic, you know, SKF. Right now, there's Gothia Cup in, in, in Gothenburg, 1,700 teams. SKF is the main sponsor. From all around the world, young people coming here to Gothenburg to play football in a tournament.
SKF is on top of this, sponsoring 25 teams from around the world, from less well-off areas of all around the world, where 450 young people get the chance to travel to Gothenburg and participate in the tournament. And I tell you, I was part of the inauguration earlier this week, and it was just fantastic to see this youth and their joy and their belief in the future. It gives you good hope for the long-term future. Okay, with those words, I turn over to you, Patrik.
Thank you, Alrik. Now it's time to continue with the Q&A session. Operator, please.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star two. Again, please press star one to ask a question. We will take our first question from Erik Golrang from Nordea. Please go ahead.
Thank you. Yeah, first question is on the price dynamics. Talked about the bit of positive impact towards the end of the quarter. If you think about the balance for Q3 and the H2 between prices and raw materials, a bit higher raw materials in Q3, but do you think that the net between them will gradually improve based on the price increases you've realized so far?
Yeah, I mean, the logic of what I said should be that. As I said, sequentially, at least what we can interpret, raw material price is eventually temporarily, but as we see it now, it is not increasing further. So sequentially on raw material, we see. And then we have the year-over-year effect for us with improvements last year, as I mentioned. With that logic, that we don't see so much negative effect, and we should see gradually some improvements on pricing, the negative price mix should improve and go down a little bit.
Thank you. Then the second question on the development in the second quarter compared to your original expectation. It seems as if industrial came out a bit stronger and auto a bit weaker than you had anticipated. Is that correct? And in which specific areas was the development different compared to your original expectation?
I'm not sure it, I mean, I alluded to that, and, you know, we talked about that many times, that this working day difference, which you can calculate in percentage if you have 1.5 day or how it goes forth and back. I wouldn't say that we came out particularly weak in automotive.
Yes, on the industrial side, I agree, we saw strong underlying demand on the industrial side. So that's, that's, I support what you say.
And then the final question, more of a perhaps a reflection. We've seen a number of suppliers on the auto side taking rather significant changes or making significant changes to their strategies to adapt to shifting technologies. What's your reflection on that, and how do you feel about your own portfolio on the automotive side relative to the shift we're seeing in the markets?
You know, this is Alrik here. I think there's one thing you have to understand. SKF is a, we're not a system supplier to the automotive in the sense that, yes, you can argue that our hub units are sort of a system, and yes, you can argue that we are working in, in the corner to develop new solutions. But basically, we are more of, of a, an expert around the rotating shaft, where we are supplying different products to the automotive industry. So when we see the combined change of technology from, going from a, a, complete integrated, traditional powertrain to the electrical powertrain, we see opportunities in the new electrical powertrain that are interesting for growth.
And we see, of course, some long-term risks that there will be parts of our bearing business and our special bearings that we today deliver to the powertrain that may disappear and probably will disappear. But this will happen over time, and we have. I'm sure that we, these factories are in a way structured so that they can actually relatively easily be turned over to making bearings, for instance, for electrical applications, as opposed to making bearings for the traditional, sorry, the traditional automotive powertrain.
So we are sort of in a different position than some of the sub-suppliers that are doing complete subsystems, if you understand, for the automotive, where they are completely invested, maybe in valves and subassembly into gearboxes and things like that. It's a completely different ballgame. So from that position, I'm not so worried, in the sense that the transition will come. I am absolutely sure it will take some time, and we will be well in line to, in a gradual way, be able to shift into the new powertrains. Having said that, also, I tell you, we're heavily investing in finding the new solutions that are the optimal for these new kind of applications that are coming.
You know, bearings that are will give the right performance in electrical motors, new ways of looking at how will the new bearings look in the chassis, et cetera, et cetera.
Thank you.
We will take our next question from Klas Berglund, from Citi. Please go ahead.
Yes. Hi, Alrik and Christian. It's Klas from Citi. Firstly, I want to come back to pricing and raw materials and ask this in a different way. So, raw materials will be worse year-over-year in the third quarter. I get this to a SEK 200 million hit, and I assume that this is still net of productivity, so the lever to compensate from here becomes pricing as cost is already done. So on my numbers, that means that price mix in the end to compensate, and I get to this number by assuming that you've been successful with the distributors, but the question is really the discussions with the OEM. So in short, do you feel confident that your price mix can trend positively around 1% in the third quarter?
You know, there are two aspects to this, and I think I've said it clearly, the same thing I said during the last quarter. There is a pricing power in the business. There, I don't see any significant changes in the kind of dynamics that we've always had in the bearing business. The key is, of course, that there are it takes time. You have to negotiate, you have contracts. Sometimes the time for the agreements that you put in place before you really see them in the figures, it takes some time.
On the other hand, price mix, meaning there are segments in the marketplace where the absolute pricing coefficient and profitability is not the same, they are different. So depending on how the volumes flow, there will be segments with higher profitability that may grow faster, or segments with lower profitability that will grow faster. So, and as I said before, in last quarter, we said it's in the making. We know we don't know exactly how this is going to turn around, turn out. It's still sort of in the making, in the sense that, yes, we have come much further, and we are discussing clearly on a completely different detail level now with most of our customers.
Some of the agreements have been closed and are coming now into effect, and some issues are still being discussed. The only big difference I would say this time, compared to the dynamics we had when I left SKF in 2005, is that in 2005, we had a period of rapid increase of raw material prices that made us sort of accustomed to general price increase discussion with our customers. This time, of course, it's the first time for many customers in a long, long time that these issues have been brought up.
And of course, then, it becomes a little bit more cumbersome in some of the making some customers understand it's completely reasonable that we must be allowed to sort of get the general cost increases from raw materials, et cetera, through. But at the same time, just as I said before, it used to be more of a buyer's market with lower demand, and now, when we are going into this new dynamics, of course, it's much more of a supplier's market, which then makes it clearly feasible to get better pay for what you deliver.
In my mind, without being absolutely precise about how this is gonna play on into Q3, there's no change in the demand dynamics as far as I see it from before.
Okay. My second one is on the automotive margin. The drop-through was only in line with the EBIT margin in the first quarter, and now we jump to an incremental margin of 35%. This is contrasting other auto suppliers that reported significant price cost pressures this quarter, and I'm trying to understand this better. You said that you had a drag from warehouse in North America last year, but then you also said it had better price mix this quarter. Could you try and quantify and rank what is the most important factor? And so explaining this step up, and why did price mix improve in automotive?
I, Christian will come in, but I just want to say, when we talk about these, the service issue we had with the change of the warehouse, it's when you compare to last year. It does not affect sort of the absolute figure. You understand? I mean, the absolute figure of reaching 8%, that's there. But the improvement being so significant from last year, it means that, of course, as this largely affected our VSM business, our aftermarket business in the U.S. last year, it means that, as this is no longer an issue this year, the comparability between what we managed last year and this year becomes extra boosted. But the absolute figure is there, that, that
No, of course. I just, I just meant the drop-through, basically.
Yeah.
No, you're right, but, I mean, if you want some numbers, I would say it's... I mean, the, the warehouse issue, which was both, increased cost and also the fact that we, we spill over, sales from Q2 to Q3 in the range of, I would say SEK 30 million-SEK 40 million, bottom line effects from that. And then, I mean, the other you said, about the price
Yeah.
The price. I mean, I think, you, we should, you should recognize that we have, I mean, first of all, we grow, which means that we take new business, and, and, I mean, with an improved price mix, it means also that we take new business with a, you know, decent, decent price, huh?
Yeah.
I mean, we don't talk dramatic changes, but, I mean, I said an improved price mix versus last year. The direction is there, huh?
Businesses that we take have a reasonable profitability for us as well. It's not, sometimes it's actually new business we are taking, and that new business has a better profitability than the previous business, and then you get a price mix improvement. What you also have to realize, again, and I go back to this, I think SKF is a component supplier. We're not a system supplier. So our situation in some of the negotiations is a little bit different compared to where you have very large systems. So what we see, there's always a price pressure in the marketplace. It's always difficult. Don't think that I'm in any way trying to do this.
The automotive customers are really very tough, but we don't see. We see the dynamics in the automotive being the same as it has always been. We don't really see any drastic change in how the dynamics are. The automotive customers are tough. They've always been tough. They continue to be tough, but we don't see any change in this compared to how it used to be in previous similar cycles.
My final one is on the European outlook year-over-year. You're now guiding higher year-over-year, and I'm trying to think about working days versus underlying demand. So when I look at how Europe developed in the second quarter, it makes me wonder where you see the underlying step up. So the segment that seems to be really moving is distribution. Automotive is flattish. There's not much momentum in energy and aero. Heavy segments are improving, but it's not that different versus last quarter. So is it really distribution that should carry this, or do you see any other segments that will move as well?
But if you look into general, you can see that there are several of the steel industry is running quite well. The paper industry is running quite well, and there are several of these process industry, because you have to understand, when you say industrial distribution, there's an underlying customer base that's driving this tendency. So, you know, it's, I think Europe is of course, we don't see the similar kind of growth that we have seen in Asia, for instance, but, you know, there's a positive tendency also in Europe, though.
Thank you.
We will take our next question from Markus Almerud, from Kepler Cheuvreux.
Hi, good morning. Markus Almerud here from Kepler Cheuvreux. Can I come back to my first question is about raw materials. So 100%, SEK 100 million headwind in Q2, and you said that would be slightly worse in Q3. What does it mean exactly, if you could quantify? Are we talking SEK 130 million-SEK 150 million or SEK 200 million headwind? And looking into Q4, if raw material prices stay where they are, what should we expect towards the end of the year? That's my first question, please.
I mean, slightly, it is rather in the range of 100- 150, yeah. I mean, it's. We are not talking decimals here. I mean, the baseline is. But it's rather that, it's not the 200, as I see it now. So and, and it mainly relates to, you know, the improvement we had last year, as I said. Q4, I, I haven't looked into that, but, I mean, the logic would be the same. It, it would be the, the, the, the change that we saw last year that would impact the year-over-year data there, and I don't have that in mind. I'm, I'm sorry.
Okay, okay. Then my second question is around the operational performance. So did you have any inventory build here, and if you could quantify that? The same thing, what should we expect in Q3?
Yeah, I mean, and on, on that, I mean, the relevant thing is, yes, we, we built inventories in Q2 versus Q1. But what's relevant is, you know, it's not components and raw material, it's, it's rather, you know, finished goods, I presume that you're after. And, and we built, around SEK 400 million in Q2 versus Q1, and it was also, I would say, if you take Q2 versus Q2 last year, we, we also that, and that, built in the same magnitude. So that's, that's where we are. I mean, looking forward, Q3, I expect the inventory levels to go down a bit, so in the range of, let's say, SEK 300 million.
Okay. And then my final question, just come back on price, just to get a sense. What is the... I mean, it sounds to you like the acceptance, there is an acceptance among customers to, I mean, to accept the price increases. Is that a fair assumption? I mean, is this a fair comment, or is it generally
Nobody likes, nobody likes to a price increase, neither do we. But just as when the steel prices go up, then we realize that you know, there's no way that we can expect raw materials and costs going up for our suppliers, and there will be no way for us to accept any price increases. Reluctantly, we will have, we have, we have to increase, accept price increases. This is the same logic for the whole value chain. So you will see, of course, customers where this is more of a mental barrier to understand that the dynamics now have changed, and you have other customers that it's more easy.
And I would always say that where you have a good relationship and you are providing good value to your customer, that's where the understanding is clear, and both parties can see that there's good value in the cooperation and there's a reason the requests are reasonable. And there are other customers, of course, where maybe the relationship is not the same, and then the discussions are tougher. So there's no sort of easy answer to your question. What I'm arguing all the time, and I've been arguing since I came in, is that the dynamics of the value chain are the same as they've always been. In the sense that you have to be cost competitive, you have to have a good product that the customer needs.
If you do, and you provide good value, there is a clear possibility for you to have acceptance at your customers for your needs when costs go up. And that has not changed now, compared to when I was in SKF until 2005.
Okay, perfect. Thank you very much for that.
Our next question is from Peter Wallin from Handelsbanken Capital Markets. Please go ahead.
Yes, thank you. Good morning, Alrik, and Christian, and Patrik. My first question is related to the workforce buildup. I'm intrigued that you managed to take on the higher demand by temps. That's very positive. And obviously, that to a larger cost than sort of fixed personnel. Will that continue on the same level, or do you see an ability for the sort of cost ramp up actually to be slightly lower ahead, given that maybe the first couple of quarters with temps will be to a higher cost? That's my first question. The other question also relates to the marketplace. I've heard that maybe you and Schaeffler have had less delivery sort of capacity maybe than the Japanese and Timken.
Has that affected you in any way, or do you feel that you sort of kept your, kept your market shares?
Well, I think that, I mean, it's always an extra, there's always an extra cost, as you say, when you ramp up very quickly. On the other hand, there's also a sweet spot when you ramp up quickly, in the sense that maintenance costs, as you start running your machines harder, tend to lag. In the beginning, you start producing, and then after a while, with higher activity, you need to increase your maintenance spend. So it's a double, i t's two, there are two effects there. And how this is going to play out during the quarters to come, it depends on, of course, on the delivery and the demand situation.
But there that these are the two effects you have, and I cannot really comment more on that than saying that. As far as delivery, well, you know, if you look at the amount of growth that we've had, I think we are doing fine. And of course, there's a always in this quick what happens, you get like a little bit of a demand starts rising. You see that maybe your inventories levels have been lower. You increase your orders, and then you see that maybe it's not so easy to get the product anymore, and you even increase a little bit more, et cetera.
I think that is normal delivery dynamics in this kind of cycles. But my assessment is that overall, I don't think that I see any big difference between us and our competitors. There will be niches, you know, areas where it's easier to ramp up, and it's been other areas where it's more difficult to ramp up. But the overall market share on a broader base will be determined, I think, on the normal dynamics of the market. Your ability to create a product that is accepted and a cost level that's in the marketplace.
Mm-hmm.
On the cost bridge, Peter, I mean, we talked about material, and I think you have that. And if you take the other parts, I mean, obviously, we are ramping up production to a certain level now, and we've added on these, temp and agencies, and so on. And then from that level, I mean, with the guidance we have, it's more to tune that than to make that a machine working in a more efficient way. So I don't see any dramatic changes to the cost level outside material, huh?
No, that's very clear. Okay, yes, finally, sorry for coming back to prices, but, but from my recognition, you alluded to around 1% negative price mix in the first quarter. And, and, given your comments, maybe it was slightly less negative than that. Is that the correct understanding? And given what you talk about, what you are aiming for, maybe continuous slide, less negative price mix also in the third quarter, but it's too early to say whether you could, whether you could reach a flat price mix. Is that what you're trying to say?
I think you have interpreted that quite well.
Okay, thank you so much for that. I get back in line.
We will take our next question from Andre Kukhnin from Credit Suisse.
Yes, good morning. Thanks for taking my questions. I just want to double-check a couple of things. Firstly, on the inventory buildup, thank you very much for giving the quantification. And just taking that one leg one step further in terms of the EBIT, impact year- on- year, are we right to think that in Q2 2016 you were reducing inventory? And I think from the conference call, I think you mentioned around SEK 110 million negative impact from manufacturing Q2 2016. So should we think about kind of positive in Q2 versus negative in 2016, or?
If I try to, and I think you mixed two things. We were in Q2 last year, I mean, the demand situation was negative.
Right.
So obviously, we produced less. Your other question, what happens to, a nd that gives, of course, negative fixed cost contribution. Your other question about inventory builds, I mean, I mean, seeing that the vacation period and so on, we usually build some inventories in Q2 to manage the summer period. And as I said, I mean, what we built now, this, let's say, SEK 400 million of finished goods, this second quarter was in the same magnitude last second quarter. So I mean, there is no, there is no, I would say, inventory build differences between the years.
Got it. Thank you. And just on the price mix to the last question, so in Q3, do you think we'll flatten out already, or is it too early, and we'll still be in a small negative?
I think we just answered that on Peter's question there, and I said that his interpretation was accurate in that way, that we never know how this plays out. I mean, we talk about months and so on, but our best guidance to you now is that it will be slightly negative in Q3.
You have to understand that, especially when you talk about negotiations with OEMs and so forth, you're going out of this sports business, if you understand what I mean? There is a time lag before you have contracts running, you know, and even if you have actually agreed on something, it takes a while before that new price level is being invoiced and also affecting the bottom line.
But I think you
There is a lag in this.
You should recognize that we started to see during this, as we said, during the later part of Q2, we started to see improvements, which obviously should follow in Q3. And then the question is: What additional can we achieve in the months to come? But, I mean, the trend is positive on price.
Right.
That's, that's the message.
The reason I'm asking is that you obviously changed your pricing structure and approach to pricing about a year ago, or a year and a half ago, and removed any kind of special pricing and the sort of rebates, discounts, which in theory should have given, should have reduced the kind of wiggle room for salespeople. So when you push through a list price increase, which I understand you did most of it at the end of April, it should just go through, and then I understand the contract lengths and then some lag from that.
But, what I'd be keen to find out is whether we're gonna get the full materialization of those price increases as per the list price, or is the net going to be still reduced, as we had in the past when there was sort of an announced 3%-4% price increase in half of last?
I think what you talk about is a different kind of dynamics, in the sense that when demand is weak, it's more difficult for any supplier to increase price, because there will be a very, very strong supply, and it will be easier, i t will more be the buyer's market. When you have a situation where demand is increasing, it becomes more the supplier's market, and that's actually, I think, more what, how you should see this, in the sense that of course, if you take during the, let's say five, six years ago, and demand was weak, and it was, of course, much more difficult to have any price increases in the marketplace than it is when demand is stronger.
I think you should see that dynamic as the more important one.
Right. Should I read this as that we're now in supplier's market with high single-digit growth rates, you've put prices up, and we'll see Q4 in positive?
It's always difficult to increase prices, and it's always a fight. But what I'm saying is that you can understand that the dynamics in an upgoing trend, when demand is higher, makes it so that you can make these kind of price increases stick, so to speak, to use your word, better than you can in a more negative market situation.
But
And that is the underlying dynamics that makes it possible, if you understand less this with different structures on the list and so forth.
I appreciate that. Thank you. Just one more question on automotive and the kind of powertrain or traditional powertrain exposure. You gave us in the past the split that I think wheel and suspension bearings were just under one half of your product portfolio, and then there were ball and taper bearing seals and then other sort of over ten product lines. How much of that other. So how much of that sort of non-wheel and suspension side is into traditional powertrain, please?
Well, you know, what I'm telling you is, without today giving you any specific percentages, I'm telling you the bearings that we are supplying, most of them, is, I mean, you could say that it's about 20%, but, and to give you a ballpark. But again, how you should see this is that this transition from traditional powertrain to the electrification of the car is happening, but it will take time.
Mm.
And in SKF, since we are not specifically making big subsystems, our factories are the kind of factories that can do any kind of bearing. Some are special, some special machines, but in a longer trend, we could refurbish most of our factories to actually do most kind of bearings of a similar size. So over time, as this change, SKF is in a rather good position to transition, and it will be the overall demand for products that will be the driving force for SKF, more than actually suddenly big subsystems disappearing, where we have special manufacturing capabilities. You understand? This is my, this is the logic. This is how you should see it, though.
Yeah, perfectly understand. Thank you. I just wanted to check the exposure. Thank you.
Yeah.
We will take our next question from James Moore, from Redburn. Please go ahead.
Good morning, everyone. All right, Christian, thank you for taking my questions. Perhaps we go one at a time. I just want to come back to the price mix. I'm a little confused. I get that we're in a good demand market, which is a supplier's market, and you've put some list price rises through, so I thought in that market they should stick, but you talk about a slight negative price mix in the third quarter. Is that because it's gonna come in after that, or is that really the net result?
No, you know, the price mix has two things. You have, on one hand, increased businesses that have increased the price. Then you have other businesses where you may have actually a profitability on the absolute business that's lower. And if you have a combination of selling those products where your profitability is lower to a larger extent, and in the cases where you have previous contracts that you have signed during, let's say, before the turnaround that happened, just if you recall, it's not until the autumn of last year that we saw the dynamics of the market trending. You have contracts that are still valid. You can run into a situation where you still have a negative price mix, even though the discussions with the customer and the actual price increases are being applied.
Maybe, if I ask there, I mean, the list price changes, they will glue, and they will glue better than in the past, but list price changes are for distribution, huh? And you know, the share of distribution of the total.
End users.
End users. But as we have said, I mean, on the OEM side, where you have, you know, contracts that have for certain time periods, this will not happen directly. So on your question, will it come later? The answer is yes.
I get it.
It will come, but they will come when contracts expire, and you know, new prices come in, huh?
Very helpful, thank you. And on the inventories, thank you for your 400 type comment. I was just thinking, if price mix is a little negative on that 567, I mean, say we're 600-ish, without being precise, just trying to think how much of that is volume and how much is absorption. Is it 50/50, or is it sort of much more volume?
Oh, I don't. I cannot. I mean, you can calculate yourself on the organic sales part, and with the, you know, price mix comments that you have got here, that they improved slightly from Q1 and so on. So I cannot give you more on exact numbers on that, but I think you should be quite close to it, huh?
Okay, and thanks. On the cost development, so SEK 222, similar to last quarter, when you said raw material, SEK 0, and this time it's SEK 100. So, I just wondered what, what's going on on the other side that's a bit better to stop that number lifting up towards SEK 300?
What's going on? You're talking about what you can expect in Q3 on that 222?
Well, I'm first of all trying to understand the second quarter, but really through a lens to see how three Qs could develop.
You have, I mean, as you know, you have a lot of dynamics. We talked a little bit about that. We had that warehouse issue last year, which had a cost and a delivery part of it. I mean, the cost there is gone, so that's positive in this year. And so, of course, you have a lot of things going forth and back on that. So, but I mean, overall, and as I said, I mean, we're still reducing staff, so we have some good developments on some part of it. So, I mean, overall, I think Q2 was nothing extraordinary as a total level. I think it's quite okay. I mean, considering that we had the material part there, huh?
As the warehouse thing drops out, and we get the slightly bigger raw mats, not that much bigger, but a little bigger, does that number materially move up next quarter, or does it just stay around here?
I mean, as I said, material will move up a little bit, huh? Slightly. That's what I've already commented. On the rest, I mean, it's all the dynamics on, yes, you're right, the warehouse extra cost is falling out, and so on, and then you have other things happening. But, I mean, I don't see a dramatic change as on the previous question there. I mean, I don't see any big changes on the cost, cost management side, I mean, versus where we are now.
Okay, thanks. Lastly, on industrial, do you think that there's been in the distribution channel, something of a pre-buy in the H1 , that could fade in the second with the timing of the list prices?
You know, there's probably been a reaction to the list price, but what we see right now is, and as you saw already during the Q2, is that we see continued demand as we are showing in our forecast and outlook. So what you could argue, though, always, is there is something called industrial dynamics, and we have talked about that during previous calls. Meaning, when there is a little bit of a tight supply and a turnaround of the business cycle, there is always a tendency for customers maybe to realize that they've had a too low inventory, and they have been pushing it, and now they need to sort of restock a little bit.
And how long that effect is and how big it is, it's really difficult to say. But there is probably more of a general situation when the supply chain change, you understand, you've been pushing down the inventories for several years, suddenly you realize, oh, I'm maybe a little bit short, and there is a sort of a maybe an industrial dynamic, making even the recovery is a little bit stronger than the underlying recovery is. And I think this is normal kind of behavior, just as when it turns down, you know, people start cutting inventories more than the underlying demand, because suddenly, you know, it's easy to get all the products, and you realize that your inventories are a little bit high. So I think that's probably a bigger effect than the actual pre-buy.
Where are we in that cycle? I don't know.
If you, if you lift yourself from speculating on the really, really short-term months and quarters, and you look at the macros, I mean, compared to when we were in this meeting three months ago, at least how we interpreted, the macro is improving. So the underlying confidence in the economy is getting stronger, which also should, of course, give some base for continued good development there.
Very nice. Thank you.
We will take our next question from Andrew Wilson, from JP Morgan. Please go ahead.
I think this is the last question, operator. We are almost 10 minutes overdue, so but please go ahead, Andy.
Hi, good morning, everyone. I'll just limit it to just the one then. I just wanted to touch on the automotive business in the U.S. where it looks like you've had a really good result relative, obviously, to the market. Can you just talk about sort of how you see that developing for the rest of the year, just specifically with, do you think you can continue to outperform in terms of, you know, relative to the market? It's been quite a good story.
Mm-hmm.
Yeah. Well, you're right. I mean, if you see it, then you know the background also that we had a program that we were phasing out. So we had the year-over-year comparisons that were negative there. And now we are growing again. We are taking business on the car side. We do also very well on the truck side. And so I mean, the underlying markets there, at least on the truck side, seems to improve. So we don't see really any trend change to that. We are in a positive trend right now in automotive in North America.
To put it in this perspective that Christian is saying, if you remember, years ago, it was why are we trading below market? We were saying that we were not on certain of the selling platforms, and we were saying it's not because of competitive situation in the marketplace. You will see that we are working hard to get back, and there will be a situation where we change that dynamics. Now we are all in this that the dynamic has changed, and we are where we are, where we should be in growing in the American market as well.
Very helpful. Thank you.
Thank you. With that, we leave the Q&A session, and we wish you all a nice summer holiday. We are here to take any questions afterwards, if you have any. So please give us a call. Thank you.
That will conclude today's conference. Thank you for your participation, ladies and gentlemen. You may now disconnect.