Welcome to this conference call for the presentation of SKF's half year results, 2015. This teleconference will take an hour. Here from SKF are our President and CEO, Alrik Danielson, our new Senior Vice President and CFO, Christian Johansson, Christina Fransén, Director of Accounting, and Theo Kjellberg, Press and Media Relations Director, and myself, Marita Björk, Head of Investor Relations. We will start by presenting the results, and then after this, there will be a Q&A session. Over to you, Alrik, please.
Thank you very much. Ladies and gentlemen, good morning, and thank you for listening in today. I have a little bit of a cold. I hope it will not be too disturbing during the conference, and I apologize for it. This morning, we released our report for the second quarter of 2015. From a profitability standpoint, I think it was a good quarter. We delivered an operating margin of almost 12%, and excluding one-time items, an operating margin of almost 13%. Sales were in line with the guidance we gave for the quarter, even though demand was a little bit softer than we would have liked. May was particularly soft, with a recovery in June. Our organic sales growth in local currency declined by 1.5% in the second quarter.
We saw good growth in railways, except in China and in energy outside of Europe. Weaker demand was seen in heavy industry and the distributor segment in North America, as well as an underlying weaker demand in China. The automotive business in North America was also slow in the quarter. We took a number of new, very interesting businesses across several industries, as you can see in the report. In rail, renewable energy, aerospace, and automotive, to name a few. I would also like to mention a new global service agreement for condition-based maintenance services to offshore platforms, where we demonstrate our ability to add value with a sophisticated online monitoring system for demanding applications. Christian will go into further detail about sales development in just a moment.
The implementation of the cost reduction program that was last launched in the beginning of the year has progressed well during the quarter. The reorganization in the three business areas is completed. Managers have taken on their new roles with high energy, and a number of colleagues adapted to their new roles in the new structure in a fantastic way. The new organization is a leaner setup, and of the total reduction of 1,500 employees that was announced, we have now made agreements covering 60% of the concerned individuals. I'm very pleased with the speed and the progress so far, and our target of reaching an annual savings of SEK 1.2 billion during 2016 is on track. In the automotive market business area, a profit improvement program was launched.
A number of initiatives have been started with a clear aim of improving the productivity and the competitiveness of the business. The structure has been simplified, and there are three main focus areas of the program that address: products, a review of our product portfolio with an emphasis on application-focused offerings, with a specific performance required for the application. Competitiveness, a drive to improve our overall competitiveness with a focus on cost, manufacturing footprint, and process technology, and vehicle service market, an initiative focusing on further adapting our aftermarket and OEM offerings. As the design level of design life of products delivered to OEM customers continues to increase, we must also adapt our aftermarket offering to this new reality, ensuring a competitive offer and value propositions for second and third vehicle owners. All three of these areas have good potential for future profit improvements.
The program will be run as part of our normal business, and any possible restructuring cost will be communicated as and if they occur. The automotive market is an integral part of the SKF Group, and the intention is, as I have already mentioned, to develop this business within SKF. I'm convinced that this program, under the leadership of Stéphane Le Mounier and his team, will improve our automotive business in the coming years. We will give you a more in-depth review of these activities at our Capital Market Day in early November. Another important area for me and for the SKF management is to focus our resources and energy on our main bearing business. In order to do so, and in order to strengthen our balance sheet, we have, during the quarter, divested three non-core businesses. Erin Engineering, Purafil, and Kaydon Custom Filtration.
The deals were closed with a total consideration of close to SEK 1 billion on a cash and debt-free basis. Activities to prune our product portfolio will continue going forward with the main decision criteria, in addition to standalone profitability, to what extent they contribute to our main business, the bearing business and rotating machinery. I would now like to hand over to Christian, our CFO. You know, Christian has been with us since mid-June, and will now take you through the quarter's financial performance. Christian?
Thank you, Alrik. Let me first start with some high-level figures before going into the details and the demand development. Our sales in the quarter was SEK 20 billion, up with 11.2% in the quarter, and organically declined with some 1.5%, adjusted for structure. Structure in the quarter referred to Erin Engineering that was divested in April. From an organic sales development, Europe was up 0.7%, North America declined with 5.7%, and Asia Pacific declined with 3.7%, while Latin America and Middle East and Africa grew with 4.6%, respectively 15.7%. If you look at the demand development region by region, and starting with Europe, we saw strong demand from railways and weak sales to energy, while other industrial market segments were relatively stable.
Automotive markets saw a relatively good demand from cars and trucks customers, and in the vehicle service market. In West Europe, sales in Italy, Spain, and Portugal, as well as Germany, had a positive development, while sales in France, U.K., Belgium, and Netherlands declined. In Central East Europe, Czech Republic, Russia, and Turkey developed well, while sales in Poland, Hungary, and Ukraine declined. North America, in line with last quarter's guidance, had a weak second quarter. Direct and indirect effects of low activity in heavy industry, mining, farm and forestry, and oil and gas, had negative effects also in the second quarter. On the positive side, we saw good growth in aerospace, railway, and in energy. The strong sales to industrial distributors in the fourth quarter, 2014, or a pre-buy, if you will, impacted the sales negatively in the quarter.
The demand in automotive was weak with declining sales in cars, trucks, and the vehicle service market. In Asia Pacific, sales came out somewhat worse than the guidance for the quarter. Industrial distribution was weak in China, where we saw destocking activities. We saw a weak quarter in heavy industry, such as metal and mining, industrial general, as well as in railways. Cars and trucks on the automotive side show good demand, while demand in the two-wheeler segment, two-wheeler market was weak. Looking to the different countries, we saw the best developments in the quarter in India, Korea, and Japan, while China, Indonesia, and Taiwan, as well as Thailand, showed declining sales. In Latin America, our sales developed positively in energy, while demand from heavy industry was weak.
Demand in the industrial market as a whole, for the region, kept up quite well, despite the macroeconomic problems in the region. On the automotive side, vehicle service market and the two-wheeler segment showed good demand, while demand from OEM cars and light trucks was weak. From a country point of view, Brazil showed increased sales despite the weak automotive OEM business. Argentina showed good growth, while Peru was relatively unchanged, and Chile, Colombia showed a decline. Industrial market, as a whole, came out somewhat worse than the guidance given in the first quarter. We saw good growth in energy and aerospace, in heavy industry, and industrial general. Demand was weak, with declining sales, as well as in industrial distribution. We do see destocking activities in the quarter following low industrial production activities.
Our customers, as well as we, might underestimating the effects on the overall industrial production from a weak domestic demand in emerging markets such as Russia, China, and Latin America. So in summary, for the group as a whole, sales was broadly in line with the guidance going into the quarter, with Asia developing somewhat worse, and Latin America better than expected. Industrial market, somewhat worse than expected, as an effect of the weak global industrial production. Let me now turn into the profit development. Our operating profit, excluding one-time items, was close to SEK 2.6 billion. Let me use the operating profit bridge here to walk you through the development compared to the second quarter last year. You'll find the bridge in the quarterly report, as well as in the released presentation material.
If we start with the reported operating profit of SEK 2.096 billion from last year, we have one-time items, a negative of SEK -75 million, being the difference between this quarter's SEK 194 million and last quarter's SEK 119 million. And these are recalculated down to last year's exchange rates, and then amount to SEK 80 million year-over-year. Organic sales decreased, as we have talked about, gave a negative contribution with 140. Currencies in translation and transaction were positive by some SEK 650 million, lower than the guidance of SEK 800 million we gave the last quarter, due to a slightly weaker dollar and euro versus the rates we saw in the end of March.
We estimate savings from the cost reduction program in the second quarter to SEK 80 million, and since December 2014, some 800 people have now left the group. Other items, and as a net impact from inflation, manufacturing, purchasing, R&D, and our IT projects, like the Unite program, being negative SEK 223 in the quarter. In the second quarter, production were lower than last year, impacting our fixed cost contribution. Cost for the Unite program on the IT side are expensed this year to a higher degree than last year, impacting the bridge in the quarter. We also see some negative material price effects from the currency development coming through on purchased material. We can roughly split the quarterly impact in three equal parts: manufacturing, IT program, and thirdly, the purchase material and others.
Operating profit for the second quarter is then SEK 2.383 billion, in comparison with last year's SEK 2,096 million. This includes then the SEK 194 million in one-time items, which, reporting-wise, is split in cost of goods sold, SEK -164 million, S&A, SEK -108 million, and then other income and expenses, SEK 78 million. Split per business area, which also can be seen in the quarterly report, is SEK 3 million in industrial, SEK -92 million in automotive, and then, SEK -105 million in specialty. If you look at the S&A expenses in the quarter, adjusted for currency and one-time items, and that we take more of the Unite costs over the profit and loss this year, and for the S&A in the divested area in engineering, our underlying S&A, expenses is reduced with SEK 75 million in the quarter, or about 3%.
The financial net in the quarter was -1 42, in comparison with last year's 335, and last year, it was included a one-time item of about 100 million related to currency losses in Latin America. The effective tax rate for the second quarter was 23.9%-ish, reflecting a positive tax effect coming mainly from non-taxable currency translation gains. Our cash flow from operations was SEK 1.2 billion. Working capital increased in the quarter with around SEK 300 million, while the net working capital as a ratio to sales decreased to 30.9% from 32.1 in the first quarter.
Cash flow from investing activities was SEK 420 million, where the sale of Erin Engineering and Research Inc., Purafil, and Kaydon Custom Filtration contributed with SEK 980 million, and the sale of a minority share and some PPE sales contributed with another SEK 60 million. Investments in the quarter was SEK 620 million, where we see higher PPE investments than last year, and lower capitalizations of the Unite costs. Cash flow from financing activities being negative SEK 3.744 billion, as an effect of the dividends paid in the quarter, as well as reduced short- and long-term debt. The debt-equity ratio improved by 9% in the quarter, from 122 in quarter one to 113.4.
Provisions for post-employment benefits were reduced in the second quarter by SEK 2.9 billion due to higher discount rates. Upwards adjustments were made primarily in Germany and in the U.S. plants. I will end here, and I give the word back to Alrik for the outlook and the conclusions.
Thank you, Christian. So let me move on to the outlook for the third quarter. And I would like to emphasize once again, that this is the demand for SKF and not an outlook on the market. As you all know, it is difficult to give an accurate outlook with such a macro environment which we operate in just now. And as we see it, the uncertainty has certainly not been reduced during the second quarter. As we enter the third quarter, we experience a relatively weak industrial production in many parts of the world, especially in heavy industry, in agriculture, oil and gas, and in some areas, industry in general. We've seen a weak second quarter for industrial production in the U.S., in Japan, and lately, a somewhat more uncertain demand in China.
My best estimate is that we, for SKF, will see a relatively unchanged demand year-on-year for the group in total, for Europe and for Asia. For North America, we expect to be lower than last year, and for Latin America, higher. Sequentially, I see a slightly lower demand in Q3 2015 than what we have seen in Q2. We expect Europe to be lower, and demand in remaining regions is expected to be relatively unchanged. The lower demand in Europe, we see partially as an effect of a lower demand in emerging countries. Per business area, we expect demand in automotive to be unchanged year-on-year, but sequentially lower. Industrial, we expect to be relatively unchanged both year-on-year and sequentially. In specialty, we also expect demand to be relatively unchanged, both year-on-year and sequentially.
In closing, I'm pleased with the result in the quarter. We have taken some good steps in establishing the new organization and in implementing the cost reduction program… We have launched new innovations, and we have taken some good, exciting orders. I would like to have seen a better sales development, but we're working hard on that. Thank you for listening, and I hand over to Marita to open for questions.
Thank you very much, Alrik. Would you please ask only one question per person? This is to allow everyone the chance of asking something. Let's go on to the Q&A session, please.
Ladies and gentlemen, if you would like to ask a question at this time, please press star one on your telephone keypad. If you feel that your question has already been answered, please press star two. Again, please press star one to ask a question. We will now take our first question from Andreas Willi from JP Morgan. Please go ahead, sir.
Yeah, good morning, everybody. My question is relating to the automotive business and what you've said this morning in terms of the improvement plan. Is there anything you can say in terms of an envelope for what that means for R&D investments and restructuring investments in general? Is there any kind of idea you could give us what that could cost and what kind of ballpark the business needs to get into in terms of profitability to be part of the SKF Group longer term? And in addition to that, the U.S. performance in auto was surprisingly weak relative to the general market. Maybe you could say a bit more about that. Thank you.
Yeah. I'll try to. We start with the first question. The automotive business is more entangled with the general SKF business than one may think. There are many synergies between product lines and in manufacturing and so forth. So it's not so easy to just say that if it does, if it reaches a certain, doesn't reach a certain performance level, it can be divested as a unit. Our ambition right now is to continue. We see our automotive business as an integral part of the SKF Group, and our intention is to continue to drive it. And when it comes to exact, we are now. We have launched these three main areas, as I explained to you, that we're going forward.
Of course, we need to improve substantially the performance of our automotive business, and that's our ambition. Right now, I'm not ready to give you any specific numbers on this. I will take a little bit more time to do that. But also, when you look at different possible restructuring, it's also difficult to give you an exactly more details on that, because that's how it works. You look into the businesses, you look into what possibilities you have, you see the different areas, and you work on it in a systematic way in these three areas. And when and if there will be restructuring, we will announce it. When it comes to automotive in the U.S., yes, you are right.
We are probably right now, temporarily, due to the way the programs run, we are now temporarily down in the U.S., more than the market. I'm confident with the kind of work and the discussions we have right now, that this is going to be, during the quarters to come, remedied.
Okay. Thank you very much.
Thank you, Andreas. Next question, please.
Our next question comes from James Moore from Redburn. Please go ahead. Your line is open.
Yes, good morning, everyone. I've got a question about demand. I look at the big negative swing in Asia Pacific from +6% to -4%, and North America has also worsened from -2% to -6%. Please, could you help us understand those two swings in growth better? For instance, in Asia Pac, was the 10% swing a 20% swing in China with positive India and Korea? And within China, is it a big fall due to the deterioration in rail? It looks like wind's better from your commentary there. It's obviously a big movement, it'd be very helpful to understand what's behind it, please.
Yeah. If we start then in China, I would say that in general, what we see is a more uncertain demand in the marketplace. And maybe what has changed since last time, mostly, is that we see now a destocking at the distributors, where there was a sort of a healthy stock level in the marketplace. And we're seeing now some tendencies of distributors being more cautious in holding stock at this point. So from our point of view, the changes has naught to do, at this moment, with any changes in our presence in the marketplace.
And then, of course, in Asia Pacific, the mining and the heavy industry-driven end user markets are still depressed in these markets, and that has continued. We have a high level of activity, so we're quite confident that we will start to see a change in that going forward. But this quarter has, in this sense, been weaker than we may have expected. And in the U.S., well, basically, we see that the destocking and the situation with industrial distributors have sort of leveled off, and we are in a good situation going forward as far as our participation in the industrial distribution market. That's more comforting.
But we also see that, the weakness in these industries, heavy industry, oil and gas, and agriculture, has persisted. And we also see adjacent OEM customers who have been working with these segments, also suffering now, and also driven also by a weaker export into the markets. And then we have this, of course, that I also mentioned in my previous section, to answer that, I would say with the kind of programs in and out right now, I would argue that we're behind the market in the U.S. temporarily on the automotive side. But I'm also confident that that will be remedied.
Just stepping back to Asia, I'm not sure I really understand, is it that China has driven that swing, and therefore is a much bigger swing and rate of growth?
Yeah, China has. The development outside of China has continued, and China has sort of, the destocking I'm talking about is to a large extent in China.
Could you give us a rough idea what China was growing at last quarter versus this? It's something that a lot of companies call out, and seeing as it's such a big swing, it'd be quite helpful to understand the magnitudes.
I apologize, I don't have that.
I'm sure you do, somewhere.
I don't have that exactly now.
We will come back on that.
We will come back on that.
Thank you very much.
Thank you, Ian. Our next question?
Next question comes from Andre Kukhnin from Credit Suisse.
Yes, good morning. Thanks for taking my question. Just want to understand the organic drop-through rate in the quarter a little bit better. Could you tell us if price mix was a positive or a negative in the quarter?
Well, as we have said before, you know, this, the price mix is many times difficult exactly for us to know what is price and what is mix. But one general comment, you can say that in a marketplace where growth is sluggish and the market is served, you will, of course, have a relatively weak possibility, so to speak, of pushing prices. And you may even see an increased price competition in a market environment like that. And I think that, that's probably the best answer I can give you at this point.
Got it. Thank you. Just the interdivisional mix, 'cause the lower margin automotive business outperformed in the quarter, would that be captured inside that line on the profit bridge, the organic sales in local currencies, or is that in the other line as well as the manufacturing?
Can you repeat that?
Yeah, please. Take it once more.
So in the past, when we looked at the mix impact, it obviously comes from selling different products and the growth rates, varied growth rates across divisions with different levels of profitability led to interdivisional price mix, sorry, mix changes. And I wonder if, in this quarter, the fact that automotive outgrew industrial being a low-margin business, the impact, the mix impact from that, would that come through in that line of the bridge that you show as organic sales and local currencies impact?
No, that, that's correct. This is for the group as a group as a whole, with the mix effects you get between the business areas. You're right, yes.
Got it. Thank you. And if I may, just, on the cost savings ramp-up, obviously, we started seeing the impact coming through, in Q2. How should we think about the profile of that for, for the rest of the year? We see the 1.2 run rate target for next year, but just how, how quickly would you expect to get there, and what should we think about for the second half?
It's difficult to give you an exact answer on that, depending on the agreements made with individuals on when they leave and so forth. But you see in the report, the yearly savings we expect from the activities quarter by quarter. And obviously, the savings will increase during the year here, but I cannot give you an exact number for 2015, respectively, what comes on top of that in 2016, up to the 1.2. But as has been said, the SEK 1.2 billion on annualized savings, we are certainly behind that, and we expect to reach that saving rate with the program that we are running now.
But the impacts will gradually ramp up, but the biggest impact will come next year.
Yeah, that's obvious.
Got it. That's very helpful. Thank you.
Thank you, Andre. Our next question, please?
Our next question comes from Colin Gibson from HSBC. Please go ahead.
Hi there. Morning, everybody. I just want to be clear. I don't think you've officially commented, Alrik, since you took over on the 15% group margin target, which I guess you de facto inherited. How should we feel about that margin target today? Should we consider that still a valid target that you still strive for, or is that, do you think, nowadays beyond your grasp? Was that a bit overoptimistic? And then a quick follow-up, if I may, and that is, I just want to understand your comments on the automotive strategy review.
... I don't think anybody expected you to announce today that you were looking to exit the business in its entirety. But does what you've said today also imply that you're not looking to trim the portfolio at all on automotive? Thanks.
Good. Okay. So, on the first question, you know, I, we in the team here, we're committed to do the best for SKF, and, and, we will always strive to create the maximum amount of cash flow over time for the group. As far as the targets, I've still allowed myself to say to you, well, we have the targets we have, and, and, and, I, you know, targets are such that, I'm I still allow myself a little bit more time before I say anything definite. So I'm just saying, we have the targets we have, and that's it. On the, on the, automotive, what I'm saying is, of course, you know, part of this, when we're looking at the product portfolio, it's pruning.
We look at the manufacturing footprint, it's pruning. But what I'm saying is, automotive is an integral part of SKF, and our ambition is to make this a good cash-contributing part of SKF, and we think we have a good plan, and we have good activities ongoing. But naturally, you know, business running a business over time is always a hard work with product portfolio management and looking at the markets and the products and the customers where you have the biggest opportunities. And out from that perspective, there will always be dynamics in the business.
Okay, thank you.
Thank you, Colin. And next question, please.
Our next question comes from Peder Frölén , from Handelsbanken Capital Markets. Please go ahead.
Yes, thank you. Good morning, Marita, Alrik, and Christian. My first question would be on the outlook. Alrik, are we, are you talking about the daily rates of activity for SKF? i.e., should we add seasonality to that?
I mean, I think it's absolutely when you start talking about daily rates and things like that, it's of course, not the way we look at it. We see it as we say it. And there is a certain seasonality, of course, if you look at, for instance, our automotive business, especially, there's always, if you look year after year, there's always a sort of-- if you're not in a mega trend, there's always a weaker Q3 than a weaker Q2, and that's what we see also here, this year. So that's no change. That's the same as we had last year and the year before that. So no, we're not on that level of sophistication.
It's just what we, what we say, the, the year-on-year, the quarter-on-quarter, sorry, the development.
I'm sorry, but it's quite important. But if you look historically, like the last 20 years or so, we have seen a quite significant seasonality of a couple percentage point. And if we should include that, and you say sequentially, it's likely lower, if we should include that, then you're actually saying flat underlying. So, so it is important, I think, for me and others to really understand this. But, but maybe it's a possibility to come back here with a clarification later on.
Yeah.
Yes, the follow-
On the other hand, this is what we see our best. You know, as I've always said, it's the big, the real, the real big swings in between quarters are very seldom seen. What you see is more of a, the underlying macro developments. And of course, this is what I see at this moment going into this quarter, and I hope I'm wrong. I hope it will develop much better.
Okay. And if I may follow up, net working capital to sales target of 27%. Christian, what would you say, what type of inventory is required to get there in relation to sales? Are we talking about 18% or 20%? What, what's a good proxy for us to think of?
Yeah, I can say I'm a bit short, too short into it in order to give you an exact number. I mean, if we look at... Certainly, the 27% target is there, and that's not changed. And we have a way to go to get there, certainly, and we will work on all three parts in the working capital, where inventory is one. We have also on the receivables side, where I think we have some improvement activities ongoing. We have also on the payables side, we have those programs to increase payment terms as well as, as you might know, a supply chain financing program that we offer and discuss with our suppliers, that all three should improve.
So I cannot give you a number on the inventory side, but for sure, we by more flexible production and more looking through the whole value chain end-to-end here, certainly we should see improvements also on the inventory side, for sure, as part of that.
Yeah, because normally you build inventory in the second quarter, and now manage to take it down, which I think is signaling an even harder or larger focus on the cash, which is very positive. Do you agree on this? That the second quarter was abnormal in that sense, that managed to take down inventory quarter and quarter?
... I have to look at my colleagues here.
Yeah.
I mean, the size of it, I think you're right, we see some improvements. I mean, the size of it, if it's, we can say that that's abnormal, I don't think so. It, we have higher ambitions than that.
Okay, thank you.
But you are right. I think that the management during, compared to the first quarter, was good in the second quarter. But again, the big thing, as Christian says here, is going to be in our ability. Accounts receivables, it's a focus issue. Accounts payables, it's a setup issue. On the capital side, with inventories and so forth, it's all about end-to-end logistics, where you understand the customer demand better, and we are now. We've put that in place, actually, so we have that now. And manufacturing flexibility, where you work on your internal technology, step up to be more flexible in your internal processes, but you also work with your suppliers so that they are more flexible, so your safety stocks can sort of be reduced.
Mm-hmm.
And that's the difficult part, because that takes time. And with the new setup in manufacturing, in both automotive and industrial, where we previously, as you know, we were running, organizing our manufacturing in business units, also in the automotive, where we now have simplified this and put it into two, sort of two organizations that are under one head and interlinked, the ability to sort of drive flexibility and standardization in manufacturing has increased. So I definitely foresee, going forward, an improvement here.
Mm-hmm.
As you know, it takes time, and it requires sometimes even investments.
I think I could add one more comment to that also. As you know, currencies impact as well on the balance sheet there.
In this quarter, we've had a positive
Yeah
... net effect from currency in what, when it comes to working capital, no?
Yes. Great, I get back in line. Thank you, gentlemen.
Thank you, Peder. Well, could you please stay to one question per person, because we have a long list, I would like to include everybody. The next question, please.
Our next question comes from Alexander Virgo from Nomura. Please go ahead.
Thanks very much for taking the question. Morning, everybody. I just wanted to go back to the guidance, and your comment on the call about Q2 coming in as expected, when, I guess, guidance was for relatively unchanged, and you came in obviously down 1.5%-2.5%, depending on whether you're looking at the group or the industrial business. And I suppose considering, Peter's comments earlier on, or question earlier on, how can we interpret that slightly down, in the context of as expected, when it didn't really come in as expected in Q2?
Yeah.
I appreciate the comment on the limiting questions, but just housekeeping: Can you give us an indication of the impact of the disposals for revenue and EBIT, so we can model that, please?
Okay, I'll start. You know, it's easy... When you look at unchanged, what, and when we guide for unchanged, of course, we have a sort of a span, right? When we're saying this. It can go a little bit up, it can go a little bit down. When you talk about - 1.5% in this environment, it's basically within what we consider unchanged, and that's why I said so. At the same time, of course, you can understand... One of my main ambitions is that we need to see a growth now coming in on our bearing business. And of course, I'm not at all pleased with it, that we are growing at this point.
But my comment is, I think anyway, that within sort of the span that you're talking about, what is unchanged, this was a minor deviation from that, and from that reason, I think it's according to the guidance. And when it comes to Christian, maybe you want to answer the other question.
Yeah, and you asked about the divestment effects on revenues and EBIT, and if you take the revenues in the quarter, it's only the average for two months, which is around $5 million, huh? And on a full year basis, as you've seen in the press release, it's $70 million. I mean, on the EBIT effect, you have the information that we have given, you can see it's reported under... It's not fully only that, but it's under the other income and expenses in the P&L.
Okay. Alright, thanks. I mean, alright, just sorry. Then the band for the slightly lower then? I mean, is that gonna be between, I don't know, low single -digit and mid-single digit? I'm sorry to press, but I think it's quite important.
Yeah. I mean, I don't know if we have published ever what we say, but, you know, when you're talking about slightly lower, well, it's between 2% and 4%.
Mm-hmm.
Slightly higher, 2%-4%, something like that. More or less flat, that's, you know, within a 2% span, up and down. You know, it's, it's, you can't ask for more. It's, you know, the world is out there, it's big and things are happening. It's difficult.
Understood. Okay, thank you very much.
Thank you, Alexander. Next question, please.
Our next question comes from Alexandre Fleury from Société Générale.
Yeah, hi, good morning. Just a question on the automotive review. I mean, products is one of the key focus areas and you're reviewing your offering. Do you think you've got the required scale, the breadth of offering to be more competitive and successful? So you were making some comments earlier just about maybe we should expect to see you prune the portfolio in certain areas, but should we also expect you to maybe make some acquisitions here as well? Thanks.
Well, in the main product areas where we are definitely we have both the customer relationships, the technology, the footprint to be a leading partner. The automotive, there are two ways, you know, in the automotive, either you are a complete sub-supplier of something like a gearbox or integral parts of the engine system, or you are more of a component supplier. And then the offerings are less bundled than you would think in the sense that if you compare ourselves to some of our competitors that are more sort of complete system suppliers, as opposed to us, where we are more focused on components and wheel ends, it's a different kind of business.
Our position is very strong in this sense, and I see no worries on that behalf.
But do you, do you think because you don't have a solutions offering or that, or that kind of approach, that you've been losing share, you've been losing content with customers?
No, I wouldn't say so. I think that with the losses we've had or have been maybe repositioning ourselves, looking at how we, you know, you start looking at the business, and there's always a cycle, right? You look at the business, you're not happy. You try to improve. You exit some businesses, you take others, and you work where you see you have your strong competitive advantage. You work with your engineering to improve your value proposition, and it's sort of a living animal.
What I said before is that when you look at the American market, I think that yes, at this point, we're probably behind the general development in the US due to the kind of programs coming in and out, but that there's no general trend. I think we're in a good position to change that going forward. So I don't see our ability within the business areas where we are anything that's very promising.
Okay, thanks.
Thanks, Alexandre. Our next question, please.
Our next question comes from Guillermo Peigneux from UBS. Please go ahead.
Hi, good morning, everyone. It's Guillermo from UBS. I actually had one question on automotive and then one follow-up on the balance sheet. The first is, you know, with your current view of the automotive division, could you maybe tell us how much of your product portfolio is actually breakeven or below, or is it something that you're not ready to share at the moment?
No, I, you know, we've launched the plan. We're working hard to change it. I am not prepared at this moment to go to that kind of detail. But I'd say I am, I'm clear that the team will over time improve our performance in the automotive. That I, that is, to me, absolutely clear.
Thank you. With regards to your net debt to EBITDA ratio, it's improving, and you know, it's still high, though. So I was wondering whether you are also thinking about, you know, the balance sheet positioning going forward. You know, given, like, lesser growth, you may think about acquisitions in the future, and at the moment, your balance sheet is not ideal. What actions do you plan to take if that is the case?
Yes. Well, as you heard during the presentation, I mean, the pruning, portfolio pruning activities, I mean, we are working on that. So there, divestment is certainly part of that in order to improve the balance sheet, as of course, the operating cash flow should over time. But... For sure, we agree, we are far from the target, and there's more to do on that. I mean, the 113 we have now as a ratio is not where we want to be, yeah. But I would also add to say that the main reason for us being behind the plan that was presented after the acquisition of Kaydon is actually the low interest rates that have influenced our pension reserves, huh?
So, if you and there's no excuses. So please, don't get me wrong, we need to fix this anyway. But, for your analysis, if you disregard that, we would have been in a better position. So I am confident that we will drive this down during the future quarters and the years to come.
Thank you.
Thank you. Next question, please.
Our next question comes from Andreas Koski, from Deutsche Bank. Please go ahead.
Yes, good morning. Can you hear me?
Yes.
Perfect. So coming back to the sequential outlook, where you guide for slightly lower demand. Looking at the different components here, you only guide for lower demand in European automotive and all other business areas, all other regions, they are expected to be relatively unchanged. So can you please elaborate about what you are seeing in your European automotive business? Do you think this is because of the underlying market situation? Is it because of market share losses, or have you actually decided to step out of loss-making businesses already?
No, no, I would actually say that we don't see that. We see this more as. If you look at the way we look, see it, we think that even the drop between the quarters, compared to other years, will actually be lower this time. So it's not a performance issue.
Would you say it's an underlying market issue?
Well, there are some, but no, I think Europe, in the car side, is actually doing quite okay, so-
Why do you expect it to go down?
Sorry?
Why do you expect demand to be lower in European automotive?
Because it is down. It's been, it's down every year. This is the way it is.
So it is a seasonality.
If you go back to eternity almost, in the automotive, the Q2, if you're not in a mega trend, the Q2 is slightly lower than Q3, sorry, is slightly lower than Q2.
Okay, so it's because of seasonality?
Yeah, it's, it's a big part of it, yes. And as I said, even we think that it's going to, it's definitely so.
Okay, thanks. May I also follow up on your net working capital target of 27% to sales? At your capital markets day last year, I know you were not CEO at that time, but you were part of SKF Group. You laid out the plan how to reach the 27% sales target. Can you please update us on this plan? When can we expect you to reach 27% in net working capital to sales?
What was it?
Yeah.
No, I mean, you're I don't think we can say when in time we can be at that level. I think we have to see and follow the trend, and hopefully we can have some good dialogue in these meetings on the quarterly performances we have, huh? But so timing-wise. But you're right, of course, we have a target there of 21.5 on inventories, for example, relating to the earlier comment on inventories, huh?
Okay, perfect. Thank you very much.
Thank you, Andreas. We have time for a couple of more questions. The next question, please.
We now take our next question from Lars Brorson, from Barclays. Please, go ahead.
Thanks very much. Good morning. Sorry to belabor the demand outlook, but I'm more curious about your North America and Asia Pacific flat outlook into Q3.
Yeah.
Can you talk a little bit about that, and particularly Asia flat, despite a very steep drop in Q2? Is that your rail business, which is a swing factor? If not, can you give us a sense of what is it that gives you confidence here in terms of stabilization of your industrial business, including your industrial distribution segment? Thanks.
Yeah, well, you know, there are some activities going on, of course. The way we see it right now, this is what we've said. But of course, given the latest macro coming out of China, this is a big uncertainty for me. This is probably the biggest uncertainty, much bigger uncertainty in looking forward into Q3 than anything about Greece or anything else, huh? I think that this what this really mean in China, as for the demand situation and the ability of our distributors, for instance, to stock up, et cetera, it's a bigger—it's an increased uncertainty. But the way we look at it and see the development right now, this is how we see it. And I...
It's difficult for me to look, give you more guidance, because of this increased uncertainty. And, on the railway side, you know, there is a lot of good initiatives, especially for us on the passenger car side, going forward. There, there, we have a very interesting deals coming up, and there's also a lot of things going on in wind. And, and we have a good, many good projects. But of course, the end of this will anyway be about what happens in China as far as liquidity, as far as the general underlying demand. We have seen an increased interest from many of our customers now to become global.
Customers that predominantly have been focusing on China now increasingly want to focus on the global to go global, and that is, to me, also a sign of that they are no longer considering the Chinese market as enough for them, huh? And that's that increases the uncertainty in this aspect. If that's going to come in the next quarter or if that's a longer trend, it's difficult to say. But the Chinese government right now is trying to prop up demand and put things back to normal. That's also clear, and we think that they will probably be relatively successful in doing so during the next quarter, and that's, of course, influencing our view. But here, I think maybe you are as good a judge as I am.
Right. Thanks.
Thank you, Lars. Our next question, please.
Our next question comes from Erik Golrang, from Nordea. Please go ahead.
...My questions have been answered. Thank you.
Okay, then we take the next one.
Our next question comes from Åsa Nilsson Brönqvist from Dagens Nyheter. Please go ahead.
Thank you. Good morning. This was covered a bit in the last answer, but I have some more questions about the development in China, especially considering the present financial instability there. How will that affect you in a concrete way? What risks do you see, and what is important for the future for SKF?
Can you repeat? You were a little bit lost there in-
Okay. Yeah.
Can you please repeat, just please?
Yes. So I'm more interested about the development in China, and what risks do you see, and what factors are important for you, and how does the situation in China affect you in a concrete way?
Yeah. Well, you can imagine, I don't know if you have seen, but for instance, in May, and now in June, there's been a weakening sales in the automotive side, for instance, where some major car companies have even had to extend financing through their dealer network, for them not to have financial troubles, huh? And you can imagine if car sales are developing and gradually being factored down, if you look at the kind of expected sales in the... When we went into 2015, and the kind of expected car sales that you see in the forecast out there today, it's a substantial change.
Of course, as people get wary of the stock exchange, and how that makes people maybe afraid, et cetera, you can imagine how that can affect their consumption, and how that indirectly also affects us. Then you have situations like heavy industry, steel production. We have known that the Chinese steel producers have, for a long time, I don't have the latest update, but for a long time, they've been producing steel ahead of demand. And in the end, we all understand that that is not possible. We know that we have a bubble or a sort of a very high production of unutilized houses and housing projects, some of them owned by the government, which are not being sold, et cetera.
And of course, if now there's going to be a drastic sort of change in the way they will be building and the construction industry will be going forward, that could affect the economy substantially. And when you have these kind of turmoils that we've seen during the last month, it is, of course, not a sign of strength.
Okay. Okay. Thank you.
Thank you, Åsa. And next question, please.
We now take our next question from Andreas Brock, from Coeli. Please go ahead.
Thank you very much. One question there on Europe, just clarification on demand there. You basically said that, you know, you know, demand is going down in Q3, but that's also very much a seasonal effect. It's almost like that. But then you said that it's the emerging market parts of Europe, which is-
Yeah.
Could you elaborate on that, please? And,
Yeah, when we see some of the weakness that we see is, of course, when there are exporting companies that have been exporting to some of these emerging countries, and they don't see the same demand going forward anymore. So it will also depend on even China. You know, there's still a lot of machinery coming out of Europe to China, and if that will continue or not, that's one of those uncertainties that we see.
Does that mean that the core part of Europe, Germany, France, U.K., et cetera, and Spain as well, are doing fine?
Well, doing fine, it's, it's maybe, maybe, depends on what you mean by doing fine. But of course, you know, we see, as we say, maybe relatively... Europe doesn't seem to be really the biggest concern on the broad basis, compared to, for instance, what we now have seen both in how the heavy industry and agriculture and oil and gas will hold up in the U.S. and the situation in China. But you know, I tell you, there are some in some niche areas, there are actually also in Europe, some signs that people are taking extended vacation at some customers and so forth. What that really means over the quarter, I don't know at this point.
Excellent. Wonderful. Thank you so, so much for your reply.
Thank you, Andreas. And, and now we are ready for the final question. So just one more question.
Our next question comes from James Moore from Redburn. Please go ahead.
Yeah. Hi, everyone. I just wondered if I could follow up on a couple of questions. The inventory drop in the balance sheet of SEK 300 million, I mean, normally, it goes up in the second quarter by about SEK 1 billion. And stripping out the FX effects, could you just give us an idea of what that had as an impact on margin from under production? And secondly, I'd just like to be really clear about the guidance, not the bands. I've always understood the two, two, two, four, four, eight, eight plus bands for your seven-notch guidance, but the mathematical basis of presentation. I think your two predecessors always guided on a seasonally adjusted basis, and you said something that really surprised me on your auto comment, that it's always down in the third quarter, and we know that. The issue-
Well, I'm not saying it's always down in the third quarter, but if you look at the last two years, if you look at last year and the year before, auto was down in the third quarter. You know, guidance is a very difficult thing, and when you're looking ahead, it's a complex material. And what I have done together with Christian and the rest of the teams here is to look on a development where we have not sort of factored in amount of on a day basis and so forth. And when I've been trying to understand what my predecessors has done before, I have also not been given a clear answer. So this is news to me.
I didn't know actually that this is what my predecessors did, and I apologize for that.
That, that's okay. But just to be clear, is it now unadjusted for seasonality?
Yeah.
So if it's gonna drop 2% for seasonality, you're gonna talk about a sort of - 2 rather than-
Yeah, we will be doing that. But on the other hand, you know, I'm not Nostradamus, so maybe you have a better view on the future, and then I think you should go with that. We're if you understand what I'm trying to say.
I do.
It's a difficult material.
Thank you. And on the inventory drop, how did that affect the EBIT, really?
Yeah. I mean, the inventory adjusted for currency quarter-over-quarter is slightly up. I would say on the EBIT impact, that's not material in that way.
Thank you very much.
Thank you so much, James. That brings us to the end of this presentation. I see that there are a few people who did have the opportunity to give their questions, so you're welcome to call me or after this call. Thank you so much for joining us.
This will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.