Good day, and welcome to the third quarter report 2015 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Patrik Stenberg, Head of Investor Relations. Please go ahead, sir.
Thank you. Good afternoon, and welcome to this conference call on the third quarter results. This call will take about an hour. Present today are our President and CEO, Alrik Danielson, our Senior Vice President and CFO, Christian Johansson, Christina Franzén, who is Director of Accounting, Theo Kjellberg , who is Press and Media Relations Director, and myself, Patrik Stenberg, Head of Investor Relations. We'll start by presenting the results, and after that, we'll continue with the Q&A session. With that said, I would leave the word to Alrik. Thank you.
Thank you very much, Patrik. Ladies and gentlemen, good afternoon, and thank you for listening in today. Many of you have followed us for quite some time and will notice that today's telephone conference differs slightly in format from previous years. In order to make the presentation more informative and easy to follow, both for those of you listening in live and those listening to the replay function, we have synchronized the slides as well as added in a few summary slides and made some visual adjustments. With that said, we will move to slide number two. Today, we released our report for the third quarter of 2015. The expected weakening of market demand that we flagged for in July materialized and gathered pace during the quarter, especially in Asia and North America. As a result, sales in local currency declined by 5%.
I'll talk a little bit more about regional performance when we get to slide number three. We responded to market developments by reducing our production rates and kept inventories under control. Notwithstanding these actions, the drop in market demand impacted our financial performance, with a resulting operating profit, excluding one-time items, of SEK 2 billion and an operating margin of 10.8%. Our focus on cash flow management continues, and I'm pleased to report a cash flow after investments before financing of SEK 1.8 billion. Christian will go into this in further detail later. At the beginning of the year, we launched a white-collar cost efficiency program that would result in a reduction of 1,500 staff. Although these are very difficult decisions to make, I'm pleased to say that agreements have now been reached with almost all of these colleagues.
Given current market conditions, these actions alone are, however, not sufficient, and we will continue our cost reduction activities across the group. Turning to the next slide, and our sales development by region compared to last year, I would like to talk you through each of our key regions with regards to sales and demand development. What we saw on an overall level in the quarter is that the global economic climate, with slowing growth rates in China and increased uncertainty about how this will impact the world economy, is impacting the industrial activity and therefore market demand. We flagged for weakened demand in both China and North America in July, and it not only materialized, but also gathered pace during the quarter, which is reflected in our sales figures, which declined of almost 11% in North America and almost 8% in Asia.
Sales in Middle East and Africa grew by 12%, while sales in Europe and Latin America were relatively unchanged compared to last year. We go to the next slide, and we talk a little bit about the industrial markets. You can see that in North America, where SKF has a large presence in large bearings, the fall in demand that were reported in July with the agriculture, mining, and construction segments, has spread to a number of segments. Sales to the railway, energy, heavy industries, and off-highway segments were significantly lower. In Europe, overall sales were slightly lower in the quarter, with significantly lower sales to both energy and industrial heavy industries compared to last year, while we saw growth in the railway sector. In China, we saw weakening demand across most of our segments, including rail and industrial distribution, while sales to the energy sector were stronger.
In the automotive, we saw sales to the automotive industry in North America were significantly lower compared to last year. SKF is currently trading below general market trends in the automotive industry due to ongoing changes in product participation. We are, however, confident that we are on the way back in the market. In Europe, our automotive business posted higher sales in the quarter compared to last year, following the overall market development, with significantly higher sales to the vehicle service market and higher sales to customers in the cars and light trucks industry, as well as the heavy truck industry. Within the automotive market, our global sales teams have also had a number of significant successes across our key markets.
Our Asian sales teams were jointly secured a contract to supply hub bearing units s for a Japanese car manufacturer's new model platform to be sold in China. In a similar deal... Our European and U.S. sales team have jointly secured a contract to supply a German car manufacturer with hub bearing units for their North American vehicle production. Our sales to the aerospace industry continue to be impacted by the weak oil market, with reduced sales for helicopter and small aircraft segments in both Europe and North America. We also experienced some product disturbances in our U.S. plants in the quarter, which had a negative effect on sales. These disturbances will be mitigated by the end of the year. Moving on to the next slide, I would like to draw your attention to some interesting new businesses that we have secured across the group.
Again, on the automotive side, having already secured a similar contract with Volvo for their future car models, we have also secured wheel hub and MacPherson bearing units for Geely's future car models, based on the same platform. Along the same theme of supporting global customers, we are now providing MAN with truck-matched wheel end units, having already signed a similar agreement with Scania. On the industrial side, an interesting development with condition monitoring, where we are providing a total solution for one of Greece's major shipping lines, equipping 70 ships with full remote condition monitoring services. In addition to the new business mentioned, we agreed to supply China Oilfield Services Limited, one of the largest ship owners in China, with propulsion shaft components and application engineering services for the new build fleet of offshore supply vessels.
In the U.S., our sales team has managed to enter into the railway freight TBU market for the first time, working directly with the factories in Italy and India to create a profitable offer for a business that SKF has earlier not been managing to break into. Turning to the next slide, and some operational highlights. Divestment of non-core businesses in order to focus our resources and strengthen the balance sheet continued with the divestment of Canfield. Our previously announced new factory in Cajamar, Brazil, to produce slewing bearings for the wind segment, opened, and a number of new products were launched, including an updated range of SKF Explorer spherical roller bearings, used in traction motors for elevators. I will now hand over to Christian to run through the financial in more details. Christian?
Thank you, Alrik, and good afternoon. If we turn to next page, sales development. Total net sales increased with 3.3% in the third quarter. The structure component in the quarter was - 0.8, and relates to the three divestment transactions completed during the year. The last Canfield impact the third quarter with one month. The positive currency effect in the third quarter is lower than the one we have seen in the first and second quarter, and relate primarily to the dollar, somewhat also to the Chinese renminbi and the Brazilian real. If you turn page, we have the trends on the organic sales growth. As we've heard, the decline in organic sales that was reported in second quarter gathered further pace during the summer.
This slide is a good illustration of the cyclicality in SKF's business, and it also highlights the importance of the flexibility in operations and costs. If you turn to next page, we have the trend on the operating profit, excluding one-time items. As you've heard, the quarter three ended at SEK 1,976 million, down from SEK 2,092 million the third quarter last year. The rolling twelve-month trend is trending at around SEK 9 billion. If you turn to the next page, we have the operating profit bridge for the quarter. One-time items, year-over-year, amounted to -SEK 130 million in last year's exchange rates. Organic sales development impacted negatively by around SEK 260 million in the quarter.
Currency impact compared to last year's exchange rates were positive by SEK 350 million, mainly due to the strong U.S. dollar. The guidance given in the second quarter was SEK 450 million, and the lower positive effect we now see relates primarily to the dollar. Savings from the ongoing cost reduction program were around SEK 150 million in the quarter. Then we have the structural impact, SEK -15 million. Other impacts includes manufacturing, purchase material, the Unite IT project, R&D, and general inflation. And here we see around SEK 200 million negative impact in manufacturing to unabsorbed cost. Of the remaining, it's around SEK 100 million related to the Unite IT projects, and the rest were R&D and general inflation. If you turn to next page, we have operating performance per business area.
All three business areas received their share of the positive currency effect in the quarter, obviously. Industrial market operating margin, excluding one-time items, was 13% for the quarter, compared to 14.6% last year. The decrease is due to lower organic sales, primarily in North America and Asia, as you've heard... and the segments also impacted there in North America: industrial, heavy, off-highway, special and industrial distribution, with a lower organic sales, compared to the previous year. In Asia, all segments, besides energy, had a weak quarter compared to last year. The lower sales volumes are also impacting the manufacturing negatively, as we said. Automotive market operating margin, excluding one-time items, was 5.7% for the quarter, compared to 4.6% last year.
This improvement primarily due to favorable sales mix, but also to improved cost in manufacturing. Specialty Business operating margin, excluding one-time items, was 11% for the third quarter, down from 13.4% last year. This decrease is primarily due to lower sales in the mining and heavy machinery segments, which is significant share of this business area. Also, sales in the aerospace industry was weak, especially to the helicopter and small aircraft business. And sales was also somewhat affected by disturbances in manufacturing in the aerospace side. Demand in the commercial aircraft segment remains stable, however. The cost in Specialty Business is also impacted by expenses related to the setup of the new manufacturing plant in Brazil, as we have released. Next page, we have the cost reduction program that was communicated in December last year.
This will be completed in the fourth quarter. We have agreements made with more than 1,400 employees out of the 1,500 targeted. Full year savings achieved with the in these agreements made will be SEK 940 million on a full year basis, and restructuring cost used is SEK 880 million so far. Savings, as you saw in the bridge, was 150 million, and year to date, 230 million. Given current market conditions, these actions alone are, however, not sufficient, and we will continue cost reduction activities across the group. We will report this program separately also in the next quarterly report, but as of next year, it will be reported only as part of the profit bridge. Turn to next page.
Profit and loss for the quarter, some additional comments. Gross margin, drop in gross margin is due to higher one-time items this year compared to last year. We have the under absorption in manufacturing, as mentioned, and to some extent, to price. Selling and admin expenses, compared to last year, on a comparable basis, if we take out structural changes, exchange rate effects, and the Unite program additional expenses, we see a reduction in S&A of about SEK 90 million compared to last year. Financial net in the third quarter was SEK -477 million , and includes a one-time item of under SEK 30 million related to negative revaluation effects due to the currency impact in Latin America. And it was also negatively impacted by revaluation effects on certain hedging activities related to the group financing.
If, also, taxes in the third quarter was a SEK -507.73 million, giving an effective tax rate of 42.5%. And taxes was negatively impacted by tax costs on the divestments of businesses that we have made in the year, and also that we have some tax losses carried forward, created in the third quarter, which we will not recognize as tax assets. The year to date, tax rate is 29.7, twenty-nine point six percent. Next page, cash flow after investments before financing. We continue our focus on cash flow, and we achieved a cash flow after investments before financing of more than SEK 1.8 billion in the quarter, compared to SEK 1.5 billion in the third quarter last year.
Looking at the twelve months rate, we amount now, that amounts now to SEK 5.8 billion. In this slide, we have adjusted for acquisitions and divestment, as well as the E.U. payment that was done in the second quarter, 2014. If we go to next page, net working capital in the quarter was 29.7% of sales. Inventories were reduced with around SEK 300 million. In the quarter, net working capital, compared to second quarter, was also positively impacted by currency. On the next page, we have the group financing position. Net debt equity was 114% end of September, which is at the same level as the end of second quarter, but is down from 127% in end of 2014.
Pension liabilities increased between quarter two and quarter three, with almost SEK 1.3 billion due to currency and reduced discount rates. But since the beginning of the year, net debt, excluding pension liabilities, have been reduced with about SEK 1.5 billion, including the dividend payment in April. Next page, debt structure maturity, completely unchanged versus last quarter, and still limited maturities in the next two years. If we move to the next page, and our guidance then for 2015, and starting with the finance net for the fourth quarter, we guide slightly more negative compared to the previous quarter due to higher volatility in currency markets.
Currency impact, based on September exchange rates, we, currency impact on operating profit is coming down from the SEK 350 million we are seeing in the quarter to SEK 250 million for the fourth quarter. Tax level below 30%, and additions to PP&E around SEK 2 billion for the year, in line with present investment pace. Next page, SKF demand outlook. In order to clarify then, what we mean, we have made a definition here. The demand outlook for SKF's products and services represents our best estimate, based on current information about the future demand from our customers, and the demand outlook is the expected volume development in the markets where our customers operate. So it's the expected volume development in the coming quarter, and it's based on raw data, and the sequential outlook is not seasonalized.
It's the raw data we talk about. With that, I'll leave the word to you, Alrik.
Thank you, Christian. And then if we go then to the October 2015 SKF demand outlook, Q4 2015, page number 21. If you look at demand compared to the fourth quarter 2014, the demand for SKF products and services is expected to be lower for the group, where demand for the automotive market is expected to be relatively unchanged, while demand for the Specialty Business is expected to be slightly lower, and demand for the industrial market is expected to be lower. Split by market, demand is expected to be relatively unchanged in Europe and Latin America, and significantly lower in North America and Asia.
Demand compared to the third quarter, 2015, the demand for SKF products and services is expected to be slightly lower for the group, where demand for the industrial market and the automotive market is expected to be slightly lower, while demand for the Specialty Business is expected to be relatively unchanged. Split by market, demand is expected to be relatively unchanged in Europe, and slightly lower in North America, Latin America, and Asia. With those final words, I open up and give back the word to Patrik.
Thank you, Alrik. Now let's continue with the Q&A session. Operator, please.
If you would like to ask a question at this time, please press the star or asterisk key, followed by the digit one on your telephone. 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. Please limit your questions to two per person. Once your two questions have been answered, you may signal star one again to join the queue, should you have more questions. We'll take the first question from Jonathan Hanks of Goldman Sachs. Please go ahead.
Hi there. Hi, Alrik.
Hi.
Hi. You mentioned kind of cost cutting in the, in the release. I'm just wondering whether you could give any more details around that, and whether we should think about that as kind of additive cost cutting over and above what you've already announced, or more defensive and just to protect the margins?
No, what you should see, you understand that, in this kind of environment, all companies, we have to work to adapt ourselves to the market demands, and we will continue to do that, as we always do. But there is, you cannot expect from us, any more general programs and things like that. This is going to be just a continuous work, like we're already doing. The first program that you saw us launching was the first attempt now to sort of get started and get on track, and now we are continuing the work within the operations, and this is how you should see it.
Okay, thank you. Very clear. And then just on North America, apologies if you already touched on this, but I was just wondering if you think you maybe lost any share, or actually, you think it was just a function of weakness in the market?
Yeah, you know, like I've tried to say also before, if you look at the overall market, and you look at SKF's position in the U.S., we are, you could call it a larger bearing company, meaning that our presence in larger applications is higher than our presence in smaller applications, where the bearings are smaller. This means that in a market downturn, where especially the bigger machinery is the one that are lagging, we will hurt more than maybe the overall market. At the same time, as I mentioned, if you look at the automotive, at this very moment, we see that due to the kind of programs that we have been awarded, we are trading below market, but that is something that we will remedy in the midterm.
Okay, thank you very much. Very clear.
Thank you. We'll take the next question from Ben Mihalik of Morgan Stanley. Please go ahead.
Yeah, thank you. Good afternoon, everyone. Two questions, please. Firstly, of the organic decline in revenues for the quarter, 4.7%, maybe give us some color, perhaps on how that developed through the quarter. Was the drop, you know, meaningfully deeper in September relative to July? Do you have any sense of that drop, you know, how much of it is coming from your customers reducing their inventory?
Well, of course, there, if you see it, we saw, as we mentioned, we saw the demand accelerate—the decline of demand accelerating during the quarter. And of course, it's naturally so that when our customers demand, when they see the demand weaken, it's just the same reaction as we do when we try to mitigate through reduced inventory, and you get industrial dynamics into the market. I think that whenever there are shifts, both down and up, industrial dynamics, if you understand what I mean by that.
Yeah.
- will have an effect. Exactly how big that is, it is very, very difficult to say, but it's definitely giving an increased volatility in the marketplace.
Thanks, Alrik. And then if I kind of follow up on the operating profit bridge, I think you said there was about a SEK 200 million drag from the negative effects from manufacturing, basically. Can you give us a sense if, if, if revenues were down nearly 5% organically, how much your production would have been down relative to last year? It doesn't have to be a specific number, just a general sense, how much you underproduced. Thank you.
Certainly, we have reduced our production rates in the faster pace than our sales decline, as I can say. We will continue to put the brake on production rates. I cannot give you an exact split of that 200, what relates to that, but certainly we have taken down our production rates more than the sales decline.
Got it. Thanks so much.
We'll take the next question from Peder Frölén of Handelsbanken Capital Markets. Please go ahead.
Yes, thank you. Hi, Alrik. I have a question regarding the outlook. You're very clear about the raw data. Could you please share some light over the sequential development from Q2 to Q3 with that new outlook, so to speak? That would be interesting to hear what the outcome actually was. Then I would like to come back to the underproduction. If I look at normal inventory to sales reduction in the third quarter, and I look at you take the responsibility and do more, which is very strong, I get it to around SEK 200 million-SEK 250 million, call it inventory take out above normal seasonality. Am I in the right range there? That's my two questions.
I mean, if I take the second one, I mean, the inventory reduction of SEK 250, you're in the right range. But your additional comment, in addition to seasonality, I cannot give you a number on, but I will say that you are in the right direction.
Okay. Thank you.
Thank you very much. We saw you on television today. You were, you were very good.
Thank you. And on the outlook, on the new outlook, clearance, what was the actual sequential underlying demand, or the sequential demand development during the quarter?
We haven't, we haven't looked back and looked into that. I'm sorry. I cannot give you that.
Okay. And could I then, as a final one then, on prices, you mentioned sort of that prices are adding to the under absorption. Could you please develop that a bit? Are we seeing negative prices on the aftermarket? Are we seeing negative prices on OE? Is there in certain segments or across the board? Thank you.
Well, you know, it's, it is clear that, in a supply market with weakening demand, there are two things that happen. And of course, this is not unique now. We are already in a readily supplied market, if you understand what I mean. So that's not new for this quarter. But of course, it's accelerating when there is weakening demand and the market is supplied, the propensity for competitors to reduce the prices increases. At the same time as in some segments, some of our customers are starting to have real issues with profitability.
They are also looking, of course, to see how they can maybe try to push a little bit extra and try to find other solutions and find less expensive products, also increasing to these dynamics. That is what you will always see, you know, a increasing demand, it's more of the seller's market... and in a decreasing demand, it's more of a buyer's market.
So what you're saying is that we see negative prices?
Yeah, I see. I'm saying that we see price pressure.
Yeah, that's very clear. Thank you. So I get back in line. Thank you.
Thank you.
From Andreas Willi of JP Morgan. Please go ahead.
Yeah, good afternoon, everybody. My first question is also on the earnings bridge and the other line. Maybe you could give us some indication on some of the other moving parts there in terms of past restructuring programs that are still supporting the earnings bridge that you show in that line. And what should we assume as a kind of a, if you don't destock, if you don't have anything else going on, what's your best guess, what this other line should be on a quarterly basis, just in terms of price inflation dynamics, basically? And the second question on your U.S. automotive business, you said before that you expect that to basically fix that on the performance relative to the market in the medium term.
Earlier this year, you, it sounded more like that's something you expected in the second half to start getting better. Maybe you could give us some indication on timing of when you're gonna reconnect with the market or are going to regain share, and even do better than the market when that happens. Thank you.
If I start with the first one, on the profit bridge and the other item there, I think we were quite, we were on... As we said, we are SEK 200 on manufacturing and around SEK 100 on IT, and it's not so much remaining for the rest. So we don't have any significant impact related to previous saving programs in the other so far, or will not have going forward either. When it comes to the fourth quarter, where we get some seasonal effects incoming with Christmas and so on, impact in that. But I would say that we are working fully with our flexibility tools now, with shutdown days, hourly base schemes, and so on there. So we are fully using that toolbox.
What that means in the end, compared to the 200, I cannot say now, sorry about that.
And on to your second question, I would say that, you know, it has to do with, programs that you're on and, new programs that you're negotiating to get in. They flow, sometimes exactly according to plan, sometimes not exactly according to plan. So I think that, of course, there are new programs that will start kicking in already by the end of the year, but I would argue that it's, the, the, mitigation of this will not come until, till, next year.
Thank you very much.
Thank you. We'll now move to Klas Bergelind of Citigroup. Please go ahead.
Yes. Hi, Alrik. Hi, Christian, it's Claes from Citi. A couple of questions. Firstly, coming back to the production levels. When we look back, looking at history, you typically do sort of significant destock in the fourth quarter when demand is weaker. You do typically SEK 400 million-SEK 600 million. Now, when you look at the destocking right now and your production levels, is that a typical fourth quarter for you right now, or are you likely to do more? That's the first question. The second question is on Asia, looking at rail and wind. Wind is still holding up, but rail continues to be a weak spot. This is now the third quarter in a row after two and a half years of strong demand.
We're hearing that sort of the high-speed tenders in China will promote much more domestic content. Is there anything here going on in terms of market shares, competition, or is this just demand-driven? Thank you.
If I take the first one on the year-end destocking and so on. I mean, in a downturn, I mean, there is, of course, a race to keep your ratios to sales on inventory. So when it comes to the absolute level of stock, the answer is yes. We will do our best to work that down towards the end of the year.
And when you, if you talk about railways, the situation, of course, that on the passenger train, which is really what's coming up, in China during the next decades going forward, and I think we are absolutely very well positioned to take, be one of the absolute main players in this. What we currently see is the freight side. It's the freight side that's hurting for us at this moment.
Okay, thank you.
Thank you. We'll now move to Guillermo Peigneux of UBS. Please go ahead.
Hi, good afternoon, everyone. Just Guillermo Peigneux from UBS. I wanted to understand a bit more about regional pricing trends. In a way I'm asking about which regions were weaker to you in terms of price mix, if you could comment on that.
Well, you know, it's... I would say that, previously it's been—the big difference we see this quarter, maybe now accelerating with a little bit weaker demand, is that you could before more sense that there was a lot of questions about whether or not the Japanese were using the lower yen to be more competitive, et cetera. Now, what we're seeing is that there's a general, sort of, more generalized... willingness to use price as a differentiator. And it's, I wouldn't say that it's particularly any market difference, that it's more, you know, these things are more related to sectors where demand is and where there is an oversupply that is more accentuated, huh?
Thank you. Can I just ask on your organic growth picture, how much maybe of or any information about how much will be actually the price mix deterioration? I don't know if you hinted at that already. I'm sorry if you did.
No, no, we didn't hint to that. But you can see there's basically one mix effect, of course, in fact, in the sense that we are stronger in the automotive market, and we are a little bit less strong in industrial. And that's one of the things that you're seeing. And of course, as sometimes in distributor segments, there's a certain destocking, there's also a mix effect there that is then against us. Even though I think that if you look at the distributor segments in Europe and the U.S., we're doing okay. So I would say that. I think that this is every customer is different. The amount of differentiation you have with every customer is different.
It's just a general understanding. You understand. I think you understand what I'm saying, that-
Yeah, yeah.
When... Yeah.
Maybe last one, actually. In terms of IT expenses, very clear about the SEK 100 million, but going forward, can you tell us more or less how this progresses on your assumptions? Thank you.
Yeah. I don't think that we will see any dramatic change going forward on this at this moment. I think that the kind of market dynamics we have today are the ones we will see on this, in this issue also for the next quarter. I don't foresee any dramatic changes at all at this, yeah.
Would you continue to spend at the same pace in 2016?
I mean, we are in an IT program. We are in different phases, and seeing what we are heading, and we are evaluating that. We are into a heavy build phase in front of us, which would talk for slightly increased spending rates, well, compared to where we are now, but we haven't worked that through fully yet.
Thank you very much.
Gracias.
We will take the next question from Sébastien Gruter of Exane. Please go ahead.
Hi, good afternoon. First question, coming back on the bridge and the organic sales part of the bridge. If I calculate in Q3, that's about 30% of the organic sales drop. It used to be 50% in Q1 and Q2. I just wondering if you have moved some of that impact into the other line item. The second question is on Specialty segment. Could you give us a bit more color on the organic growth decline in that division? Is it driven by GBC, PEER, and Kaydon? I mean, which businesses have, have seen the worst performance in the quarter? Thank you.
On the bridge there, and on the organic sales, we have followed the same way of reporting as in the past, so there is no principle changes there. If you look at the Specialty Business, we have a few different... I think we have commented the bearing side, where we are in Specialty, very much tweaked to the heavy industry mining sector, which has been quite severely declining. We have commented the aerospace, where we had the twofold impact there, one on the helicopter segments and the small aircraft related to, I would say, the lower oil sector.
And also, that we had in Q3, we will remedy that for the Q4, where we had production disturbances on deliveries. And for the rest, I would say we have our second-brand businesses in Specialty, where we are doing quite fine, except for the agri side, the agriculture side, where we are seeing quite a drop.
Okay. And just coming back on the organic sales question on the bridge, how do you calculate that impact? What assumptions do you make?
Yeah, I mean, the assumption is our assessment. I mean, it's with the gross margin impact of the organic sales decline.
Okay. Thank you.
Thank you. We'll now move to Alasdair Leslie of Société Générale.
Yeah, hi, good afternoon. A few questions, please. Just, you obviously highlighted sequential deceleration in demand through the quarter in North America and Asia. So just how about Europe? Did you see any signs of a slowdown there in September, particularly from kind of export-driven OEMs? And then tied into that, industrial distribution in Europe looked like it was flat in the quarter versus a sort of mid-single-digit decline in your general industrial businesses. Do you think there's a latent danger of a destocking phase still to come in Europe in Q4 and perhaps Q1 next year? Thanks.
...Well, there's always, as I said before, there's always a possibility that you see industrial dynamics playing a role here. But my feeling is that it's relatively stable in Europe. If we don't see any changes going forward, I think Europe is relatively stable. That's my assessment. And when it comes to America, I think the same. I don't think we will see the kind of pre-buy that we saw last year, for instance. Yes, that's a big difference. We're handling the distribution business differently, and this is not something that is particularly helpful from a complete value chain perspective. That's a change that you may see in the U.S.
I still believe there's this de-stocking going on in Asia, and particularly in China.
Okay, thanks. If, if I could just have a follow-up, and you kind of alluded to it earlier in your—in one of your responses, but we've, we've kind of heard of end users downgrading equipment specification in, in certain areas like oil and gas and mining, et cetera. I was wondering for you, whether it's just whether you've seen this in, in those kind of isolated end markets, or, or whether it's, it's gonna be more broad-based than that, i.e., in, in some of your general industrial markets.
Yeah, it's of course a... There are two, I think there are two trends. If you really look at it, what happens in a situation like this. On one hand, there is the trend of maybe some of our customers feeling that they are under a competitive situation, which makes them feel prone to look at the downgrade, yes. But on the other hand, there's a definite need for many of our customers to look at reengineering of the product as well. And I tell you, I really feel an increase in the interest for many of our customers to work with them on reengineering of their product portfolio. Because, of course, if you honestly look at it, what you can do through...
What kind of cost reductions you can do through reengineering, of course, it takes longer time. It's something that you-- it doesn't materialize immediately. But the kind of cost reductions that you can do through reengineering is, of course, much superior to actually sourcing a cheaper component for a deal that you're doing. So I see these both trends. There is a certain sometimes propensity to sort of look at if I can lower my cost through a different product in this specific component or, and on the other hand, I need to review my product portfolio and upgrade to be more competitive. So right now, we-- I think we see both of these.
Okay, great. Thanks. Thanks, Alrik.
We'll take the next question from James Moore of Redburn. Please go ahead.
Yes, morning, everyone. Morning, Alrik. Morning, Christian. I wonder if you could perhaps elaborate on China. Feels pretty important to understand at the moment. Could you perhaps give us the organic sales decline in China this quarter, and tell us how it compares to last quarter? And how did that look for all three of the divisions? I'm really trying to understand whether Pier GBC is falling harder in China than the industrial division.
Yeah, well, you know, the main, the main influence of Pier, Pier and GBC is actually not in China. That is something you should also understand, that the main, the main part of our second brand portfolio is actually sold out of—outside of China and not the least in the U.S., huh? So that's for one. And then, Christian, what do you say?
I mean, when it comes to your question on China, we were in automotive some 4% lower than last year on cars and trucks. And we were doing, in fact, better on the aftermarket on the VSM.
The industrial versus Specialty picture in China?
Yeah, the Specialty is not the big part here. In industrial, without giving you an exact figure, it was a bit about the same kind of decline we had in the two quarters.
Thanks. Secondly, I know you guys aren't Nostradamus, but can you perhaps give us your production planning? Do you expect your degree of destocking in the next quarter to be bigger than that of this quarter?
Yeah. You know, when you are in a... As you said, you know, thank you for remembering, this, I appreciate. The thing is that when you have a weak demand like this, if you look at the macroeconomic indications, the only thing you can do is to be prudent and plan for a production lower than sales. And since then, also, normally, sub supplies in a weaker market is more readily available. It is so that the risk you're taking by being more conservative on your production planning is can be easily mitigated if you're wrong, so to speak. So, we are being conservative in how we plan our production for the next quarter.
Okay. But just very quickly, finally, could you remind us of the split of your China rail between freight and passenger?
Yeah, we don't do that. But as you can see, if we're doing fine in passenger so far, and rail, of course, historically has the big being the big business in China. It's right now in an all-time low, and what we're looking at more is actually refurbishment and reconditioning of units as opposed to larger business. So you see, I think you see that. Otherwise, you know, the figures would look different then.
Am I right to say that freight is bigger for you guys than passenger?
Yes, yes. Historically, yes.
Okay, thanks.
Thank you. We'll take the next question from Andre Kukhnin of Credit Suisse. Please go ahead.
Yes, good afternoon. It's Andre from Credit Suisse. Just a couple of questions left. Firstly, just on the bridge, looking at the Q4, and thinking about that -200 that you saw in Q3, you were already destocking in Q4 last year, and the other line already expanded. So are you planning to destock by a higher amount than you were destocking last year in Q4? Because from what you said, it sounded like you implied that -200 repeats in Q4, while it shouldn't, if you're just taking out the same amount of stock this fourth quarter as you did last year, fourth quarter.
No, I cannot, we haven't done that bridge versus last year, but it's also, as I first said, we have the flex toolbox there, and I don't have the details yet on how much of the cost of what that means in terms of converting it, I mean, to get cost out in the fourth quarter there. So I cannot give you an indication versus the 200 more than that. Our ambitions, high ambitions are that we are not going to, we are going to keep our ratios, inventory to sales also in the fourth quarter, despite declining sales.
Right. Thank you. And just on the flexibility on the toolbox that you mentioned, what's the dynamic in that? Are you kind of ramping up the usage of that, and therefore, there should be an increasing benefit to your operating profit from that? Or is this something that you've already ramped up and kind of the usefulness of this is diminishing, just to understand it?
Yeah, I mean, and you know that in different countries, you have different legislations and different possibilities, too. So the toolbox looks very different, huh? So in some markets, you don't get a 100% effect from what you do in terms of cost reduction. In others, you get a better outcome of it. So, I mean, we are working. We have in some situations, you have some delays until you get the effect, so I cannot give you an overall on that. But we—I would say we started to ramp up the use of the toolbox here, let's say, in the midst of the quarter, you know? Of the third quarter.
Got it. Thank you. And, can I just ask on the U.S., industrial destocking? It's something that seems to have been going on for, I think, best part of two years now. What's your view on this going forward? How much longer can it last for?
That's a very good question. My personal feeling right now is that the situation with the American industry distributors is flattening out, so to speak, yeah. That we see now a development. What we will not have, I do believe, in this year, as we had last year, we had a pre-buy last year, and this year we are not incentivizing pre-buy. It doesn't add anything in the business, actually. So I think there will be a lower pre-buy factor this year than last year.
Very clear. Thank you. And sorry, just one more question. On U.S. Automotive, you've described very clearly what happened in terms of tracking below the market and why that happened. Can you just share with us how you're planning to gain that share back and how soon?
Yeah. You know, what I'm trying to say, really, is that it's more of the kind of programs that you are devoted to and then actually SKF losing competitiveness in the American market. That's what I'm trying to say. This is more like, you know, you've been working on some programs, you got them, some others you didn't. The platforms are shifting between the your participation between different brands, and right now, this is giving us a lag in the marketplace as of... compared to the market. But it doesn't mean that SKF is not on the ball in the U.S., and that we're working and with good traction to mitigate that in the midterm. That's what I mean.
Got it. So it's simply that you didn't get some of the work, because maybe the customer was conscious of the division being put up for review, maybe changing-
No.
ownership, and now that's resolved, and you should be getting-
There are many reasons why this can happen, and how the platforms are sailing and how you are between different brands. What's important for you to understand is, this is a temporary thing, and it's not about SKF competitiveness in the marketplace.
Thank you very much for your time.
Thank you. We'll take the next question from Erik Golrang of Nordea. Go ahead.
Thank you. I have two questions. The first one on the guidance definition there. You say it's on volume, so that means price mix comes on top. Is that correct? And then also the magnitude, if there's an update on that also, what does lower mean?
Yeah, I mean, it's correct. Price mix is not included in that definition. It's outside on top. And the magnitudes, I think we have mentioned that in previous meetings, and we have relatively unchanged, means plus or minus 2%, slightly lower, 2% to 4%.
Thank you. And then the second question on is to Alrik now. You're three quarters into this job now. Could you say something about the where... How you would allocate capital in SKF going forward? What are the real sort of strong areas in the group which you think you can build further on and strengthen?
Yeah. Well, you know, there's one of the areas I think that, as we have said, technology, in the end, will is going to be absolutely key to... And it's both technology, product and service technology, as well as manufacturing technology. And we will try to be very focused on the kind of investments we do in technology going forward. And one of these things that we are showing is with this new investment we're doing in Gothenburg, with a state-of-the-art production line for spherical roller bearings, of course.
Then, as you can understand, in this kind of climate we are now, it's more of understanding where do we have the best manufacturing units, leverage on them, and then try to rationalize part of the footprint to get a better cost base, and that is actually what in the short term, we're focusing on.
Thank you.
Thank you. We'll take the next question from Lars Brorson of Barclays. Please, go ahead.
Thanks very much. On the Specialty Business, Alrik, can I just understand why it is that you are notching up the outlook, as it were, or the implied growth from the outlook? You're, you're implying slightly lower, or you're stating slightly lower from Specialty, up from a negative decline of 8% in Q2. Why is that for a business which is weighted towards North America and China? I'm trying to reconcile that with your regional demand outlook, which obviously is for North America, significantly lower in Q4. That's the first question, please.
Well, you know, one of the things is one of the impacts, a large part of the impact is that we had a production disturbance in two of our factories related to the aerospace business, and that has been fixed. I have personally been there and looked at it. It's been fixed. There are some extra costs that we're still incurring in the fourth quarter as phasing out the mitigation that we did for this interruption, and that is back on track, yeah. And that's one of the reasons, so.
Okay, so just to be clear, on the 250 basis points margin decline in Specialty, how much was the impact from that production disturbance? And of the SEK 200 million from manufacturing levels in the quarter, how much would relate to your Specialty Business of that, please?
I'm not sure I have that split, but I would say that on the aerospace production disturbance, I would say we have, if I would, some SEK 20 million.
Thanks, Christian. If I can just maybe one final one, just on your CapEx guidance raised to SEK 2 billion from SEK 1.7 billion. Just remind us again, sorry, I was a bit late on the call. What's driving that upward revision to your CapEx guidance for the year?
It's the programs or the investments we have approved, which is a lot about upgrading our manufacturing sites. And we have some currency impact in that also, obviously, with the fluctuations we've seen during the year.
Thanks.
Thank you. We'll now move to Olof Cederholm of ABG. Please go ahead.
Yes, hi, it's Olof Cederholm with ABG. Just two quick questions. First, on the cost level going forward, you say that the cost focus will be more in terms of general improvement programs rather than these big restructuring programs. Could you guide us a little bit in terms of what you expect in terms of cost for this? As I assume, it would still mean some restructuring costs going into 2016.
No, for sure. And as we have said, I mean, and I think everyone's organization's wish is that you have a built-in cost consciousness, and you work with your productivity on a continuous basis. And that's what we mean also, and we have activities, clearly, that will be continued moving forward. And it's, you're right, it's not without cost to implement it, but I... We don't have a guide for you on that for now on.
So when we have activities, we will announce them as they come. So we will let you know, but we will announce them as they come.
Okay, fair enough. And then, just on your balance sheet and ways to make that stronger, are there other assets like Canfield that are on the sell list and that we should see being divested over the coming year or so?
I mean, we don't speak about neither acquisitions or divestments before they occur, but certainly, we have both an acquisition and a divestment pipeline that we are working with constantly, yes.
Okay, thank you.
Great, thank you. I think we have to close here for questions. We all thank you for attending this conference call on the third quarter, and if you have any additional questions, you know where to find us. Thank you.
Thank you very much, and hope that we talk again and that you listen in next quarter. Thank you very much for listening to SKF.
Thank you.
We'll conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.