Morning, ladies and gentlemen, and welcome to the SKF first quarter report conference call. At this time, all participants are in listen-only mode until we conduct a question-and-answer session, and instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero on your telephone. Just to remind you, this conference call is being recorded. I would now like to hand over to the Chairperson, Marita Björk, Head of Investor Relations. Please begin your meeting, and I'll be standing by.
Thank you very much. Ladies and gentlemen, good morning to you all, and very welcome to this conference call for the presentation of SKF's first quarter results, 2012. This will take one hour. Here from SKF are our President and CEO, Tom Johnstone; our Executive Vice President and CFO, Tore Bertilsson; Ingalill Östman, Senior Vice President, Group Communications; and myself, Marita Björk, Head of Investor Relations. Tom will start by giving us a presentation of the results, and then there will be a Q&A session. Over to you, Tom, please.
Thank you very much, Marita, and good morning, everybody. As you saw earlier this morning, we released a report for the first quarter of 2012, and I think it was a good report, very good report. It was in line with our expectations going into the quarter in terms of sales, operating profit, and we delivered a good cash flow. What is very striking, though, is the very different development in our business when we look at the regions throughout the world. In addition, and as planned, we continued to run production below sales to reduce inventory, and that, of course, impacted our results. I'll come back to both these points a little bit later. During the quarter, we continued to take steps to strengthen SKF, and I'd like to start by looking at a few of them.
Just after we released our full year results in January, we announced that we'd reached agreement to acquire General Bearing Corporation, or GBC, as they're known. As you know, part of our strategy is to develop a second-brand business for SKF, and our first major step was with the acquisition of PEER in 2008. The acquisition of GBC will significantly improve our product assortment and customers served by the second-brand business. Their range of ball and tapered roller bearings, which are sold under the General and Hyatt brands, are very complementary to the current PEER offering. GBC sales today are primarily in the USA, whereas their manufacturing is undertaken in four plants in China. As we have done with PEER, we intend to globalize their sales and, in particular, build their business in China.
We hope to complete this acquisition in this quarter, since the necessary approvals have now been received. Another step which we took during the quarter was to step up our innovation and activities, our innovation activities, both within the opening of our new UTCs, the ones in Gothenburg and Luleå, and through the launch of a number of new products. I will not go into all of these here, but I'm particularly pleased with the number of new products coming from our lubrication systems business. The integration of R&D is going according to plan, and we start to see the benefits of this. By the way, just, for information, our lube business is also developing very well with strong growth overall and operating profit.
We are investing in our R&D as a group, which is the right thing to do for our long-term development and fully in line with the initiatives which we launched late in 2010. For your information, in the first quarter, the increased R&D impacted our margin by some 0.3% compared to the same quarter last year, but it's a good investment for our business. We've gained a number of new businesses, some of which we were able to announce and highlight in the report, such as the new business for the wind industry with Vestas, the new business for railway with Siemens, and the wheel end and transmission bearing business with Scania, which will mean that we will start manufacturing these bearings in Brazil, which will for Scania, which were previously imported there.
This will help support Scania, but also support our other truck customers there. Finally, at this point, I want to highlight the new industrial market organization. This is well under implementation. I have personally met a number of customers who welcome this new approach. I believe that as we go through this year, we will increasingly see the benefit of this approach with our ability to create and deliver new value for our customers, our increase in the launch of new products, and importantly, a more efficient way of running the business. Now, let's get back to the financials of the first quarter, and let me first start with the volume development. In North America, we saw a very strong growth in our business, which was led by the increase in sales in the automotive industry.
The positive development of the light vehicle production in USA, which was up some 15% that, combined with the new business we've gained, resulted in a very strong volume growth. But we also grew very well in the industrial business, with good sales growth in virtually all our major industries in North America. Energy grew for us, both traditional and new renewable. Off-highway was strong, as was aerospace and our lubrication business. We also saw a very positive development in our sales to our industrial distributors. North America in total has been very positive for SKF during last year, and this has continued this year. In Latin America, we saw a positive development also. All main markets showed very good growth for us, Peru, Chile, Argentina, and not forgetting the largest market, Brazil. Our growth actually is quite broad-based in, in Latin America.
In Europe, the development was very much as expected. The industrial business had the best growth, with sales to renewable energy, aerospace, railway, and our lubrication business developing very well.... Sales to our industrial distributors also held up very well, despite the uncertain market sentiment. As expected, though, we saw a major decline in our sales in the automotive business. The car industry, heavy truck industry, and vehicle service market all suffered. For the car industry, our sales were down more than the market due to the mix of our business, and we expect this trend to continue in the second quarter. Our sales to the heavy truck industry, although down, showed signs of leveling off in the quarter, which I think is quite positive as well.
Moving over now to look at Asia, and here we saw the biggest decline in our business, and our sales were in Asia were lower, much lower than expected. This was driven by significantly lower sales in our industrial business and particularly our business in China. Although I must say that even though January was weak, and even if I discount the Chinese New Year, January was weak, we saw some improvement in our business as we went through the quarter in Asia. So let me start now by saying a few words about China and what we saw for our business there. Our decline in sales was mainly in the industrial businesses, with the continuing weak renewable energy business and weak railway business, which we have commented on before.
I would say we still expect to start to see some recovery in our sales to renewable energy in the second half of this year. I can also confirm that our sales to the railway industry for freight cars will improve in the second quarter as well, due to new business and new contracts that we've gained. We said it would improve in the second quarter. We expected that, and I can confirm that to you. We also saw some weakness in the industrial market in our sales to our industrial distributor there. I think that the steps which have been taken to reduce money supply and cool off the economy have impacted our sales to them and their sales out. As this is being eased in the country, we expect to see some improvement as the year progresses.
But it wasn't just the industrial business that was weak down there. Our sales to the automotive, and in particular, the car industry, were impacted due to model mix, because we are down. We primarily on medium and large cars, which have suffered following the end of the incentive scheme. Our truck business is small in China, but it developed very positively. So if I look at it overall, what you saw in China was weaknesses in our renewable energy, our railway business, our sales to industrial distributors, which was into general market and our automotive business, which is specifically the car business. Other industries down there developed quite well. Turning over to India. Here in India, our sales were relatively flat year-over-year. And that means they didn't develop as positively as they have done before.
It was quite broad-based in India, I've got to say. There were some segments up a little bit, some down. For example, in automotive, cars were better, but trucks were a little bit down. In our industrial businesses, our sales to Off-highway in India were better, but to renewable energy were a little bit down, et cetera. So it was a mixed picture in India, and I think our development was very much in line with what's happening in the marketplace. So China was down for us quite a bit. India, relatively flat for us, but it's not all down in Asia. Some of the other markets in Asia were doing very well for us. So if we look at markets like Korea, Malaysia, Thailand, Indonesia, et cetera, these developed very positively for SKF.
So let's summarize the first quarter in total for the group. I'd say volume was broadly in line with what we expected there as a group, but with a slightly different mix. The Americas, both North and Latin America, doing better than we expected, and the Asia being weaker than expected. Let me turn over now to what we did in manufacturing. We decreased manufacturing as planned in the quarter, and it was significantly down year-over-year. This enabled us to reduce our inventory, mainly in finished goods, and that's by over SEK 300 million in fixed currencies. You will see a bigger figure when you look at the balance sheet, but nearly half of that figure in the balance sheet is due to currency. Just over SEK 300 million was due to inventory reduction in fixed currencies there.
The major reduction was in our industrial operations. So I think the team has done a good job and in line with what we expected there. If I look at the second quarter for inventories, we don't plan to reduce inventories in the second quarter. They may even go up just a little bit. That's due to us getting ready for the summer shutdown, which we have in our European factories. So manufacturing will be up in the second quarter compared to the first quarter, but still, the manufacturing will be lower than a year ago, when we had an actual record level of manufacturing in the second quarter last year. So that's sales and manufacturing. Let me turn now to profit development. If I look at, first of all, raw material.
Raw material costs were higher in the quarter, due, but due to the positive price mix of 1.9% and the other steps we've taken, we were able to offset this. In the price mix figure, I should say that roughly one point, nearly, half, half of the 1.9%, roughly one point, was due to the interdivisional mix. The operating profit was, was good, was SEK 2.14 billion, and our margin was 12.6%. I think with the headwinds of much lower manufacturing and higher raw, raw material costs, it was a good profit development. And we must remember that when you look at this compared to the first quarter last year, we had two different dynamics in place.
Last year, we were ramping up our production and had really great absorption in our plants, and we also produced last year ahead of sales, so building inventory.... In addition, steps that we were planning to take to increase our R&D and our investments in salespeople had not taken place last year. This year, however, in the first quarter, we were breaking our production and so running it lower than sales, so we had the opposite cost absorption issue. So I think with this as a background, it was a good result and very much in line with what we expected for the quarter. I said it would be quite similar to the fourth quarter last year, and, and it was. Our cash flow was good.
As you all know, the first quarter is normally a low quarter for the group due to the higher working capital, but at nearly SEK 700 million, I think this was a good start to the year. Inventory went down, but our account receivables were up, primarily due to the higher sales in March, replacing the low sales of December. Currency was, when we started the quarter, we expected currency to have a positive impact of some SEK 75 million in our result, but the currency changes during the quarter meant there was limited impact on our operating profit due to currency. For the second quarter, we expect a bigger impact with a positive SEK 125 million, and now we expect some SEK 200 million positive for the year, compared to some SEK 400 million when we published our full year results.
So let me now move on and look at the outlook for the second quarter. We expect to see an improving business for the group, both sequentially and year-on-year. All business areas should also see a positive sequential development. From a geographical viewpoint and talking sequentially, we expect North America to continue the positive development and be slightly higher sequentially, Europe to be relatively unchanged, so we feel it's our business in Europe is leveling off, so it's unchanged, and Asia and Latin America to be sequentially higher. When we look at the second quarter growth on a year-on-year basis, so second quarter this year compared to second quarter last year, I think the pattern is very similar as in the first quarter. The Americas, both North and Latin America, showing the best growth.
Europe, we expect to be relatively unchanged, but the trend that we saw in the first quarter continuing in the second quarter for Asia means that we expect Asia to be relatively unchanged year-on-year in the second quarter. From an end market viewpoint, if you look at the different industries we serve, I think basically we see trucks now leveling off sequentially for us in total. At the other side, aerospace and rail, we're going higher sequentially, and rail, we do, of course, through the China business coming in, and all other industries being slightly up sequentially, which is the same as the group. From a manufacturing viewpoint, we will take the manufacturing level up from the first quarter in the second quarter to be able to manage the summer shutdown, as I mentioned earlier.
But I've got to say, we will still be lower compared to the record second quarter manufacturing of last year. Let me turn over now and look a little bit at raw materials and what's happening in raw materials at the moment. I'd say all the main contracts now are completed and show some ups and downs, but overall, base prices are slightly up for the group this year compared to last year. If we look at specifically the second quarter, then we will face slightly higher raw material costs than the second quarter last year, and that's due to the surcharges. Because if you look at it just now, today's surcharges are slightly lower than the average of last year, and they're lower, of course, than what we saw in the second quarter last year.
But what we see in the books in the second quarter this year is what we had as surcharges from the early autumn last year. So that will have some, some impact on us year-on-year. So raw material will be up a bit on last, compared to last year on the quarter. So what we doing about it? Well, we're continuing to work with our three actions. One, sourcing, to do what we can do in sourcing, to see what we can do to offset the increase. Secondly, we're working on cost reduction, as we always do. But thirdly, we're working on price increases. And at this point, I'd like to comment that we've announced list price increases of around 4% in both Europe and USA, and these will come into effect from the beginning of July.
And these price increases in these two major regions will help offset the higher input costs we are facing. So if you put that together, volume, manufacturing, and raw materials, et cetera, what does it mean when looking at the second quarter? Well, first of all, I want to remind you again that the second quarter last year was an all-time record quarter in terms of manufacturing and sales for the group and in profitability. I said at the time, we were in a sweet spot when it came to cost absorption and effectiveness, and we were. We built inventories in the second quarter, and this, we will not do this year, well, at least not to the same extent. So we'll have some under absorption there, so not the same cost absorption as we had last year.
We will face higher raw material costs in the quarter compared to a year ago, but we will benefit from slightly better sales. Let me close now just by saying I think we've had a good start to the year, with good profit, good cash flow. We continue to invest in our business, and we see a somewhat more positive development in our business than just one or two quarters ago. With that, I want to pass back to you, Marita, and then we can go over to questions. Thank you very much.
Thank you so much, Tom. Let's go on to the Q&A session. Please say your name and company name.
Ladies and gentlemen, if you do have a question at this time, please press star followed by one on your telephone keypad, and to cancel your question, please press the hash or the pound key. Once again, that's star followed by one to register a question and the hash or the pound key to cancel. There'll be a short silence for participants register for questions. The first question comes from Fredric Stahl from UBS. The line is now open, sir. Please go ahead with your question.
Good morning, Marita. Good morning, Tom, Tore. Hi, it's Fredric at UBS. I have three questions, please. The first one is simple: If you can quantify the under absorption in the quarter? Second, I want to talk a bit about APAC. The region came in quite a bit weaker than you guided for at the full year results. So I was wondering what surprised you there, and how confident you are that it's now improving again, and why you see that improvement? And then finally, there was an explosion at the chemicals company in Germany here a few weeks back, a company called Evonik. And I was wondering if you have heard of that, and if you have seen any indications from your customers that production flows are being impacted here in the second quarter.
I don't think it's directly related to you, but it's certainly related to some of your customer segments. So-
Thank you.
Thank you.
Okay. Thanks for, thanks, Fredric. Good morning. Let me take the last one first. Yes, of course, I'm aware of the, what's happened there, and, and I think it will impact into the automotive, side there, especially in certain things, in injectors and things like that. We've not seen any impact of that on our, our, business yet, and we don't hear anything from our customers about specific impact on that at this stage. That's, of course, something we need to monitor. I mean, it seems the automotive guys go through these things on a regular basis now. You had the tragedy in Japan last year, then the floods in Thailand, and now you have this, there. But, we don't see anything specific on us just now.
And the under absorption, I'd only go in to quantify it, but I can say it was quite significant. If you take in fact that compared to sales, the under absorption was with inventory reduction of somewhat more than SEK 300 million. Compared to last year, it was significantly more than that, of course, because last year we built up inventory. And the under absorption, when you break in, as I said before, quite quickly, that is more significant than this sort. It was quite significant in the results there. In terms of Asia Pacific, you're absolutely right. It was a weaker than we expected going in. I think the big issues there we really saw is India didn't perform quite as well as we expected. They've got some issues there with slower growth, with
But also with some liquidity in India as well, which we see it's affected the general industry down there. In China, we had a worse performance, I think, in industrial distribution, where again, that is big liquidity issues for our distributors there, where they are not getting the right money, and of course, their customers are not getting the money right to be able to do things. So that impacted there. I think automotive was a little bit weaker than we expected as well, overall down there. And these are two very important parts of our Chinese business. The rest of Asia. So one other area I didn't mention, Taiwan was down quite a bit for us as well, and Taiwan was machine tool related.
There we saw a drop off in our machine tool business in Taiwan. The other parts down there in Asia developed in line with plans. So it was these factors that influenced us. And of course, when you look at China, China is 45% or so of our Asian business. If it's not running the way it should, then it has a big impact, especially these businesses, which are our major businesses in China. What makes me feel more confident? I've been looking at the daily sales rate, and I've been having a number of discussions. I was down in Asia just a few weeks ago and met the Asian team, went through the business with them in detail, as our business unit presence.
I've been down there doing that, and we see the number of actions in place. We also see orders in place. For example, the big order we've now got from the railway business, it's very, very positive for our railway business, and that's an important part of China as well. And we see some signs that other businesses are starting to move, orders are coming in, things are moving there. So that's what makes me the positive, that we're, we're on the right track, there just now. And as I said, when I look at the -- we're still not moving into growth in the second quarter. We're still expecting the second quarter to be, year on year, relatively unchanged, there.
It is based on the information we get and some of the orders we've already taken and the development we can see in our business.
Great. Thank you.
Thanks, Fredric.
Thank you, Fredric. Next question, please.
The next question comes from Nicholas Dill from JP Morgan in London. The lines are open.
Good morning, everyone. It's Nicholas Dill from JP Morgan. Three questions, please. First of all, the industrial division. I'm just sort of trying to understand what exactly happened there. We see the sales up organically by about 250 basis points. We see the margin coming down by about 310 basis points. You've given a number of explanations for the group. I was hoping you could dig a little bit deeper into this division, which surprised me a little bit negatively this quarter. Second question is around pricing. If I understand you correctly, Tom, the price increases will start to filter through from July.
That means that the raw material impact could actually affect the, the sort of second quarter a bit more, and then sort of we should see that to be sort of priced away in the second half. Just sort of wondering whether I understand that correctly. Then thirdly, on the under absorption, I quickly looked at the quarter last year at the sort of inventory developments there, and I actually saw inventories moving down a little bit in Q1 versus sort of December 2010 by about SEK 150 million. I just sort of wonder whether you can give us the figure there, what happened there, excluding the currency movement, so we get a better understanding of what happened year-on-year in terms of the under absorption.
Yeah. If I take the inventory figure, last year, first, I'll take that first, if I could, Nico. If I look at that, the under absorption was, or the inventory impact, like I said, there was SEK a few hundred million were put into inventory last year in the first quarter, and I did comment that in the quarterly conference call, there as well. So what you saw happening with the inventory going down was a currency impact, as we see this year as well. If you look at the inventory this year, it goes down, I don't know, SEK 600 or so in the balance sheet, but it's only, over SEK 300 million in fixed currency, and that is due to the currency impact there. So that was it.
So it was SEK a few hundred million put into inventory last year and a little bit more than SEK 300 million taken out of inventory this year. So that's the difference there with it. If I do in reverse order as well, the prices, yeah, they will come in from beginning of July in Europe and North America. They're announced to the marketplace. In the first quarter, with a 1.9% price mix plus the other actions we took, we were able to offset the higher raw material prices. I expect we'll be able, with the price mix and the other things we're doing in the second quarter, to be able to do that as well, there. And then, of course, we will get the benefit going forward of the price increases into the third quarter in total.
Back to SI, yeah, I mean, the SI issue is related to the fact that we pulled down their manufacturing quite a bit. Of the over SEK 300 million in inventory reduction, the major part was in the industrial business there. So that really hit them, and they hit the brakes pretty hard in the first quarter. If you take in the fourth quarter last year, it was the opposite. It was automotive that really hit the brakes there. It was industrial that did it in the first quarter. So that's why you see that impact in them.
Very clear. Thank you.
Thank you.
Thank you, Nico. The next question, please.
The next question comes from Ben Maslen from BAML London. The line's open.
Yeah. Morning, everyone. It's Ben Maslen from Merrill Lynch. A couple of questions, please, Tom. Firstly, just on Europe, can you talk a little bit more about what you see there? You know, you say it's fairly flat, but a bit more color on what the different country developments, you know, east versus west, north versus south, how that developed during the quarter. And then just coming back to pricing, there seems to be quite a few pricing investigations going on in the industry. I know you maybe can't talk about those, but can you just talk about the environment that there is in terms of you wanting to put through prices? Is that more difficult now because of these investigations, or they're not really having any impact? Thank you.
Europe. Yeah, I mean, that's a good point. If I take Europe, it's a mixed picture in Europe. You've got the north-south divide, east-west divide there. If I take East Europe, East Europe's developing well for us. Which markets do we put into that? Turkey, very strong development, CIS, Russia, developing very well, for us. So markets like that developing well for us. Whereas if you look at France, Italy, Spain, they're down. They're down. They're down year-on-year, quite significantly in these three markets, due primarily also to what's happening in these countries, but automotive impact as well hits us quite a bit, especially in France and Italy. But I've got to say, generally, these markets are down, for us.
But what I can say is, if you actually look at their trend over the last 3, 4 months, they're down a lot year-on-year, but they seem to have found a level. That is, that when I look at daily sales activities, it's not dropping more in these markets, is that we can see at the moment. It's holding fairly stable. So it's come down, and it seems to be stabilizing a little bit. Germany, we see actually, even with the automotive impact that we've got from trucks and cars in Germany, we see a positive development in Germany. Germany is a little bit better for us year-on-year, and that is due to the fact that the industrial business there is doing very well. Our sales to renewable energy is strong there. The off-highway sales is strong, et cetera.
So Germany is quite good, and Sweden and Northern Europe is quite good for us there. So there is a different picture as you put it. So I'd say from the first quarter, what we saw a very big drop-off in South Europe, but seems to have found a base. East Europe, developing okay for us and moving CIS, Russia, et cetera. Turkey is doing very well for us. In Germany, okay, but it's industrial. Automotive is down quite a bit, and up the north is somewhat better, or Sweden, a lot somewhat better.
Great. Okay, thanks.
Welcome. Oh, pricing. Pricing!
Yeah.
Pricing. Yeah, sorry, Ben. On pricing, yeah, no, I think the environment is always tough to do things and do prices. These investigations don't impact that. We've got to run the business, and we got to run the business, there. And what we do is make the judgment calls on what we think is right for SKF to do. And the fact that we've now announced them publicly, these prices, is why I can comment to you there. Nothing beyond that. We just run the business as is, Ben, there. So nothing different than that.
Great. If I maybe just have a follow-up on the-
Yeah.
On the tax rate was a bit higher in the quarter. Are you still happy with 30% for the year, or are there any, you know, mix changes?
I would be happy with a lot more than 30%.
Yeah. No, sure.
Tony can't get me there. He's working on it. No, seriously, I think that's an interesting point you raise. If I look at taxes, what we can see clearly is, there's very different tax rates in different countries around the world. And the, for example, North America has got a much higher tax rate than the average. I think North America's tax rate is only 40%.
Yeah.
So when we see the mix of business that we've got, that can have an influence on the average tax rate in the, in the group. So we still see 30% as a, as a, as a good figure, as an average there, and of course, we need to work towards getting there. But the mix of the business has an impact, and that's what helped hit us in the first quarter. The North American and other businesses, which have got a higher than the average tax rate of the group, they did better than the ones that have got a lower than average tax rate.
For example, China has a tax rate of 25%, and of course, when that doesn't do as well, then the impact of the two together, with North America doing better and China doing, not as well, means that the average for the group goes up.
Got it. Thanks, Tom. Very clear.
You're welcome, Ben.
Thank you, Ben. Next question, please.
The next question comes from the line of James Moore from Redburn. The line is open.
Good morning, everyone. I've got a few questions. Tom, if you compare your pure price, excluding mix, to raw material impacts in a kind of time series over the last year and looking forward, without the numbers, could you help us on where the best or worst point was? I'm just trying to understand really whether the next quarter's raw material hit is tougher than it's been or whether it's easing. Secondly, it looks like you did a couple of % of underproduction in the first quarter. What does the second quarter look like there? You've said you'll lift production in the second quarter, but will it actually be under or overproduction?
Yeah.
What sort of percent are we talking about? Then thirdly, R&D to sales and sales cost to sales-
Yeah
have both been a source of a bit of a headwind there. I'm wondering where we're at on absolute percentages and relative to where we're going. Is there, is there a future hit there?
Yeah. Yeah, good, good questions. You've been busy. Okay, let me take that one by one. R&D to sales, 2.5% in the first quarter, that's up about 0.3% compared to a year ago. The average last year was around 2.2% as well. I would say I don't expect it to go up much more than that. So I think 2.2 in that sort of arena, we should run there. And I don't look upon that as a headwind. That's an investment in our business. That is something we need to do for our long-term development. The ramping up of the centers in China and India are absolutely vital for us to maintain our leading position in these markets, and we will invest heavily in that, to do that.
The growth of new products coming to the market is very important for us, so that's where we are in R&D. If I take S&A as a % of sales, the S&A, I think we're more or less at the level we should be at the moment. They were 13.5 at the first quarter. We won't see that. I don't expect that to go up as a % of sales. In fact, we have activities underway to see how we can become more efficient in that. So it won't go up much, but hopefully in the coming quarters, maybe not the second quarter or third, but as we go forward, we can bring that down a little bit as a % of sales.
Okay.
In terms of Q2 production, Q2 production is. I said we would not take inventory down in the second quarter. We maybe actually put a little bit inventory in to manage the summer shutdowns of the European plant. So from that, there won't be an under absorption versus sales. However, our production is quite a bit lower compared to last year. Last year's second quarter was the record production level for the record production output for the SKF Group, and we'll be lower than that. Yeah, so compared to last year, we'll be down, but compared to the first quarter, we'll be up, and we won't under absorb versus sales. But we'll, of course, compared to last year, be down quite a bit.
In terms of pure price, I don't have that off the top of my head, James, but what I can say is I don't expect the raw material headwinds to be tougher in the second quarter than it was in the first quarter.
Okay, that's helpful. But just coming back on the underproduction-
Sure.
So you're talking about some positive volumes year-on-year in the second quarter, which is certainly better than a lot of us have thought. But can you help us with the quantum of how much production is down? Because presumably it's the production that'll impact the underlying margin.
The production impacts the underlying margin quite a bit. No, it's down quite a bit. It's lower, it's down quite a bit. I don't want to give you how many percentage points, but it's quite a bit down compared to last year. That's our plan.
Okay. All right, thanks.
Okay. Thanks so much, James.
Thank you, James. Next question, please.
Next question comes from Colin Gibson from HSBC. The line is open.
Thanks very much. Hi, everyone. It's Colin Gibson, HSBC. Three questions, please. First of all, just looking at Chinese growth rates, clearly, your core scenario is that these recover, perhaps start recovering already in Q2, can recover perhaps a bit further in the second half. What do you think? How big do you think is the downside risk to that scenario? And I'm thinking particularly, you've talked a little bit about winning orders in rail, for example, but renewables sounds like it's still pretty slow. And how do you feel about sales to distributors? Do you think there is a risk that that really doesn't recover all that much until next year?
There is, after all, an argument that, you know, with so many new people taking over in the Chinese leadership, that no big decisions get signed off on anything, and presumably including monetary easing until next year. That's the first question. Second question, can you talk a little bit about... Of course, you mentioned the price increases you're planning in Europe and North America, which sounds fantastic, but can you talk a little bit about the pricing environment in the Chinese market and also in the Indian market? And then last question, slide four, you've highlighted a couple of actuator product launches, and it just struck me, looking at those, we don't hear very much about the linear motion business at all nowadays. How core do you see that business for SKF?
Yeah, good. China. Let me look a little bit about China in total. Yeah, we've got new business coming in for rail. What you can see in the rail market is that their plan for freight car production this year is roughly in line for as the plan for freight car production last year, and they didn't do much in the first quarter. So, and the first two tenders have been done, and we've done a good business in these two tenders. So from that viewpoint, I'm very confident with the rail business that we're gonna see during at least the next couple of quarters there with it. Regarding renewable, I mean, it's clear that renewable is something that has been an important part of our business development in China.
Actually, the first half of last year was our record levels for a renewable business in China, and then it hit the wall in the third quarter, or the end of the second quarter and the third quarter, if you remember, yeah. How confident am I in that? Well, I can only say that we, we've had a lot of discussion with the customers down there. We've looked at the items in the pipeline, et cetera. And our best judgment is, and a confident judgment is that we should start to see the sales moving in the third quarter there, and into the fourth quarter as they work things through, there.
That's not looking at any big recovery in the market, that's just looking at things being worked the way through in the chain in total there. That will not have a huge impact in our manufacturing because we will ship from inventories primarily. If I look at the distribution, yeah, I mean, the issue in distribution is clear that even with the change in leaderships, et cetera, coming in, first of all, there is already some steps of monetaries, and you can see the reserve requirement ratio going down a little bit just now. Will it go down? How much more will it go down? Good question. Your guess is as good as mine. But the underlying demand will need to start to be serviced and moved there.
So the business with our distributors there, which is down year-on-year at the moment, will need to improve anyway, just to service the underlying demand that is there in the market. So it will come up, but I've got to say, my forecast for China this year, not to have the type of growth we've had before. We were down in the first quarter, and we will move back into growth for the first full year, but it's not a dramatic growth in total. So I'm not an extremely optimistic, or overoptimistic in that one. I think it's a based and balanced view of what we can see developing there.
So let us switch to the and we've got some new business, by the way, in China, I could say, for other businesses. New automotive business kicking in this year, the truck business kicking in for us this year for CNHTC. We started some deliveries there, so that will help us as well. So but that's my view in China. On the pricing environment in both China and India, yeah, I mean, we're working on that to move prices. It's a tough market, yeah, but it's tough everywhere to move prices. We've got the combination of our three tracks in the especially in the Chinese market, and it's working, which is, you know, keep pushing the value products in there and getting advantage of that in the market.
Secondly, application specific for the market, such as the CNHTC, but we've got some other examples of that, and thirdly, the second brand there. And that enables us then to put the right value into the different areas of the business there. So it is tough, but yes, we're active in doing things on pricing in the marketplace there as well. Linear motion, good point you raise on that. We don't talk a huge amount of linear motion there. It is an important business for us, and the guys are doing, are developing that business. You know, we made a couple of acquisitions in, in Asia some time ago, and so, and they're developing, and we've been upgrading them to SKF brands, et cetera.
So I'll get Henrik to talk a little bit more about linear motion business at the capital market day when you're there, so you get a little bit more flavor how it is. But it is still important business for us.
Thanks very much.
Thank you, Colin. Our next question, please.
Next question comes from the line of Guillermo Peigneux-Lojo from Morgan Stanley. The line is now open.
Hi, good morning. It's Guillermo Peigneux-Lojo , Morgan Stanley. Hi, Marita. Hi, Tom. Maybe just a couple of questions when it comes to headcount investment, and especially now that it seems like emerging markets are improving sequentially to some extent. Are you happy with your current sales organization there? Are you, let's say, continue to invest on those markets, adding headcount? And then the second question is, what kind of wage inflation have you seen across regions? So, in basically mature markets as EU and U.S., and also in emerging markets.
Sure. Hi, Guillermo. Yeah, the headcount, yeah, we're still, even in the first quarter, we're still putting some more headcount in to, for example, Southeast Asia, where the growth is there. The service business has developed well for them, et cetera. So that type of work, where we see sales opportunities and sales business, we will still keep pushing ahead with the work to get more feet on the ground, because you've, that's the way to sell, that's the way to get the value for the customers there. How many in total that will be this year? Let's wait and see. It won't be as much as last year. We did 600 or so last year. It won't be quite as much as that this year, but there will be some in the frontline going on board there.
Regarding wage inflation, yeah, of course, it's quite different wherever you are around the world. Double digits in certain areas of Asia, low single digits in Europe, in North America. Roughly for the group in total, we expect something around about 3-ish or 3-4%, something like that, is the wage inflation in the group. And of course, the pressure we put on our organization is to offset that with by productivity.
Oh, okay, thank you. And a follow-up, can you comment a little bit on utility prices and energy prices?
Yeah, they're up. They're up. Yeah, we've been—we're seeing up, and it's interesting. They're up a similar amount in both the controlled and the non-controlled markets for us there, which is interesting, when you look at, you know, the, the difference in how utilities do. But they are up. I think utilities in total, I do feel the top end is SEK 1 billion or a little bit more than SEK 1 billion for the SKF Group as well. So they are up there, low single-digit % or low- to mid-single-digit %.
Okay, so is it fair to assume that all these headcount plus wage inflation, plus energy utilities sequentially will be moving up in Q2 as well?
Sequentially, I would say wages a little bit, yes, because of when the contracts are done. Utilities, no, I think most of that should be there already. For me, headcount, yeah, but not significant there. So it'll be wages have a little bit more of a headwind in the second quarter.
Okay, thank you.
Welcome.
Thank you, Guillermo. Next question, please.
The next question comes in of Martin Prozesky from Bernstein. The line is now open.
Good morning, everyone. It's Martin from Bernstein. A few questions, please. The first on auto. You haven't spoken too much about auto in terms of the outlook at this stage. It seems like the destocking was much less in the quarter than we had in Q4, and therefore, the margin came back quite nicely. Can you just give us a outlook for the various geographies? We've seen quite conflicting data points coming out of especially U.S. truck. So that's the first question. The second on the geographic outlook, can you comment a bit more on your confidence in the strength in the U.S. recovery and LatAm?
In particular in terms of LatAm, so what sectors are doing so well that, you know, drove the strong performance and give you confidence in the outlook there?
Yeah. Okay. Automotive, let's take that one first, Martin. Yeah. If I look at that, then, let's take the light vehicle in total. In Europe, we expect... I mean, light vehicle production was down in the first quarter, and we expect light vehicle production to be down year-on-year, again in the second quarter. There's a variety of different forecasts. The latest we've got is around 9% down, and we'll probably do a little bit worse... than that. In North America, light vehicle production will be up something like, from the figures we can see, something like 19% year-on-year, there. When it comes to heavy vehicles, like heavy trucks, for example, first of all, North America is not a big heavy truck market for us, so it doesn't have a big, big influence on us.
But we reckon it will be relatively flat quarter and quarter in North America, from our business there. As I say, it's not a big business for us. As you say, there's a lot of different views in what's happening there in North America. In Europe, what we think is we've hit the bottom in our truck business in Europe, and we seem to be stabilizing around that level in the European market for heavy truck there. But we're down quite a bit year-on-year for that there. From an automotive market, from the business area viewpoint there, yeah, you're right. In the fourth quarter, we under absorbed more 'cause that was the inventory reduction.
We took more inventory reduction in automotive than we did in industrial in the fourth quarter, and it was the opposite in the first quarter. That's where you see some improvement in the margin there for them. In terms of U.S. recovery and LatAm, let's take LatAm first, Latin America first. As I mentioned in my speech a little bit earlier, Peru, Chile, et cetera, doing very well, and of course, that's mining-driven, end-user-driven type business, and that has developed very well for us in total. In Brazil, our service business, which was into the paper industry, et cetera, is developing and food in that area, developing very well, and our sales to distributors developing very well, our sales to the vehicle service market developing well.
These type of industries seem to have a good, positive outlook for that when I look at them in Latin America. In terms of the car business in Brazil, the car business in Brazil is weaker than it was year-on-year there, but not worse than we expected there at all. But it's a bit weaker year-on-year down there. What's my confidence? I think the activities we have in these markets, we've got a good activity level in the markets, and we see the outlook from the distributors and our customers there is quite positive. But it's more driven by our service and sales with distributors and sales to end users in that region than it is to the OEM industry there.
In terms of USA, I mean, we see a good development in the U.S. business. It's been running now all through 2011 and start of 2012. I'd say, as I say, in automotive, we see production going up year-on-year. We have new business in automotive. We've gained some new business for the light vehicle business in North America, and that's why we're performing better than the marketplace there. When it comes to the industrial business, we do see traditional energy. Traditional energy in . . . When I say energy in North America is doing well for us, it's more traditional energy than renewable there. Of course, longer term in renewable, we need to see what happens with the PTC and other things. It doesn't . . . A lot of questions on.
Within the other sectors there, off-highway, going very well for us. Our industrial drives business, which is pumps, compressors, et cetera, going well for us in North America. And we see that continued, from an outlook from our customers in the second quarter and going on. And I think we're gaining a little bit in the North American market.
Thanks. Just one follow-up on the Auto Europe. You mentioned in Q4 that there was destocking happening at distributors as well.
Yeah.
Is that now mostly done?
We still. We didn't see any recovery in the first quarter. It's a good point, that. We didn't see any recovery for the vehicle service market in the first quarter in Europe. In fact, Europe, I mean, well, of course, compared to the first quarter last year, first quarter last year was a very strong quarter for vehicle service market, so we're down quite a bit in Europe this year. But we didn't see any recovery, so there's. I would say it's not got worse, but it's not got any better yet. So that, my judgment would be, yes, the destocking is over, but we don't see the improvement coming yet.
Great. Thank you.
You're welcome.
Thank you, Martin. Next question, please.
Next question comes from the line of Arnaud Brossard from Exane BNP Paribas, in Paris. The line is open.
Hi, Arnaud Brossard, Exane BNP Paribas. Hello, Tom, Tore, Marita. One question on PEER first, your non-SKF brand, which is not included in any of your business areas, if I am correct. Could you please tell us a bit about the sales and earnings trends of this brand and how it compares with Chinese players in particular? Because if I remember well, it mostly competes with these in China. Could you also tell us whether you intend to add disclosure on non-SKF brands once you have acquired General Bearing? And finally, you've mentioned quite a few potential headwinds or tailwinds for the coming months throughout questions and answers.
Could you just please, Tom, give me a brief recap of what you see in terms of headwinds, tailwinds, when you take into account raw materials, wages, headcount, manufacturing levels, et cetera? Just a quick recap, if possible.
Sure. PEER , let's just do that. Hi, Arnaud. Yeah, PEER is doing very well for us as an operation. The bulk of its sales are still in North America, but it's growing quite a bit into Latin America, step by step, especially Europe, good development there, and it's penetrating into the Chinese market. As you rightly say, it competes with primarily Chinese players there in the market, and it's developing well. You can see, actually, when you look at the profit consolidation on page nine of the report, you can see some figures on profit there outside the business, and that's primarily in the PEER-type business, and it's developing well. Good operating margin. Absolutely good operating margin, supporting that margin in total and developing okay for us in total.
Yeah, GBC will come in and run as a separate business alongside PEER going to market place. And as I say, it's very complementary in how they go to market. Will we put the two of them together and start to report? That's something we, we can look at. It's not gonna happen this year. Let's see, we'll have, we can have a look at that for in the future there in total. We keep it in there as a operations outside the three business areas in total for some time there, I think, which is, I think, the right way to look at that. That was that question. What was the second question?
Just a recap of headwinds and tailwinds.
Yeah, yeah. That's right. I, I'd written something down. I couldn't read my writing there. Okay. Headwinds, yeah. Headwinds, tailwinds. If you look at it, first of all, from a positive viewpoint, second quarter versus last year, we will see the sales being somewhat better, and we will see a positive price mix. And of course, you've got positive currency compared to last year. On headwinds, you have got raw material, and you've got higher costs for doing business, higher R&D, higher sales and administration expenses, and of course, you've got the underabsorption that you've got versus the big production level we had last year. I think these are the two major elements you should have. The pluses, as I said, the sales price mix and currency.
The minuses, which are related to the raw materials, to the cost investments in R&D and S&A, and the headwinds of the underabsorption.
Which ones do you expect to weigh the more?
I could give you a forecast. I, not to be too honest, I think we—it's a very good question. If you actually look at it, the underabsorption will be quite significant still into the second quarter. And the reason being is that last year, in the first and second quarter, and we highlighted that a lot, that we were in very much a sweet spot, and I keep using that word, sweet spot. We were getting a lot of benefits out of our manufacturing.
When we were looking at the productivity, the output, the results we were getting from our manufacturing, from the volumes we were putting through, they were really the drop-through was quite significant, and that enabled us to go up to the 15 in the first quarter, and I think it was 15.6 in the second quarter, enabled us really to do that there. That was not a normal type development that you would normally get. It was because we put it up very, very fast, and we got that. We're getting the exact opposite impact there. So I think last year we did much better than we should have done with the volumes we had. This year, we'll do somewhat worse. So I think if you look at the two, the headwinds will be greater than the tailwinds.
Thank you.
Thank you, Arnaud.
Thank you, Arnaud. Next question, please.
Next question comes from Alexander van den Berg from Berenberg Bank. The line's open.
Hi, good morning. Just a really quick one, actually. You mentioned, I think, at the full year results, restructuring charges this year of SEK 200-SEK 300. Could you give us some idea of what you took in Q1 and the remainder for the balance of the year?
Mm-hmm. That's a very good question, Alexander, as well, there. Maybe I should have commented that in the speech. We didn't take anything in Q1 in restructuring. But of course, one of the things that we're working on just now, as I mentioned before, is how do we see the footprint going forward, especially when one looks at the European market environment for some time? So even though we see it being relatively flat just now, I think the bigger question is how do you see it developing over the next two, three, four years? And how much more positive will it become, if more positive there. So therefore, what we're looking at is our manufacturing footprint in Europe. We're looking at our business footprint in Europe, and of course, you always look elsewhere in the world.
So yes, we expect to take some restructuring this year of SEK a few hundred million. We're working on things just now. I would not be surprised if we come to some conclusions either late second quarter or sometime in the third quarter to do some things. Yeah, so we won't wait till the fourth quarter just to wait for that there. But I have nothing I can say right just now. I mean, we're still doing the scenarios because it's very. You have to go in detail plan by plan, or let's say, business by business, to see what it means there. So yes, there is likely to be SEK a few hundred million, and it will come, I expect, before the. It normally comes in the Q4.
Okay. Thank you.
Thank you, Alexander. Now we have time for a couple of more questions. Please, next question.
The next question is from Peder Frölén from Handelsbanken. The line's open.
Hi, Marita. Hi, Tom and Tore. So, let me just start with the underabsorption again. Sorry about that. I mean, the FX impact was around SEK 300 million, Q and Q now. How much was it ex FX in the fourth quarter? I think it was SEK 500 million included there. And, on that question, will the drop-through, what's the drop-through on the underabsorption? Was it higher or lower in this quarter than the fourth quarter? That question is taking into account, of course, that you have to break very hard in the beginning, but also where you actually underproduce, i.e., automotive versus industrial.
Sure.
So that's my first question. My second question is on China. You mentioned the new contracts coming upstream. Could you help us a bit about the contribution this year in terms of new businesses in China? And finally, I mean, is it fair to assume that the interdivisional mix would be down in the second quarter versus the first, given that automotive might be not as bad as we saw in the first quarter, or is that too negative assumption. That's it for me right now.
Okay, thanks, Peder. Yeah, yeah, the last point, yes, the interdivisional mix will be a little bit less in the second quarter versus the first quarter.
Yeah.
Going back to China, sorry, back to China, the new businesses, yeah. I mean, the new business we've got in railway, that's important. New business we've got in the truck for CNHTC, we didn't have last year. That's important new business that we've gotten, and we're gaining a number of new businesses in the general marketplace as well. Because as I said, it's not all down in China. The general market drives business is doing well in China just now there. Do I have an exact figure on that?
I don't have that in the top of my head, but there is a number of new positive businesses kicking in now from now on, and that's why I am more positive in putting the trend up there, because of the new businesses kicking in for us there.
Okay, that's fair.
Sure.
If you look at China first quarter, you take out rail, you take out wind, you look at sort of general industry, and you look at the off-highway market for general industry, what was the negative here, organically, on those two segments?
It was, it was a... If you take general- if you take drives out of it, I would say, if you take in total, the, the areas that were down for us, take renewable and rail out, automotive was down, the car business was down for us and industrial distribution. They were the two main major areas that were down for us, there. The drives business and that were up for us in, in, in the, in China, there with us there. They were down fairly important, not the same amount, each of them, but the special distribution was down fairly important for us, there.
That is sort of 10%-20% in your-
Fairly important, for us. I don't want to give an exact figure.
Sorry about that. Yeah. Final question.
Yeah, and under absorption thing there as well.
Yeah.
Yeah, the SEK 500-600 million in the fourth quarter was absolute reduction that we did. 500 million was not currency related, and that was absolute reduction in the fourth quarter. And then the absolute reduction was a lot, as I say, more than SEK 300 million in this quarter here. And the absorption impact is against the first quarter last year. You, you've got two impacts. One is how much we took out under relative to sales, and the second one is how much we took out relative to the production.
Mm.
Last year, which was running ahead of sales. So we're putting SEK a few hundred million in last year. We took SEK a few hundred million out this year. Yeah. So you look at the two extremes, and that's the absorption. Was it more in the first quarter than the fourth quarter? I would say similar or maybe just a slightly bit more, but similar, because the industrial guys normally carry a little bit heavier weight in them there. But not dramatic, yeah. It would be similar or a little more, but not dramatic.
Very clear. Thank you for that.
You're welcome, Peder. Thank you.
Thank you, Peder. Now let's take the last question, please.
The next question comes from Sébastien Wetter from Société Générale in Paris. The line's open.
Hi, good morning. Two questions, if I may. The first one will, if you could help us just with the bridge on margin, Q1 this year versus last year. I mean, you mentioned the headwind from R&D, 0.3%. Cost inflation seems to have been offset by productivity price. So, I mean, basically, the 270 basis points decrease year-on-year, if you exclude R&D, is related to under absorption and mix. Could you quantify both? Are we talking about half impact for both? And my second question would be about currency impact, on a sequential basis, on a year-on-year basis. You mentioned SEK 125 million, but just wondering if you have some positive hedging effect in Q2 versus Q1.
Okay. I'll take the last one first, if I could. The currency sequential, I don't see big differences, sequential Q2 versus Q1. Yeah, so that won't have a big impact. If I do Q1 this year versus Q1 last year, as you said, the price mix was able to offset the raw material and other things, et cetera. So put that away. Then you have the issue on two things that were higher than cost. As you rightly pointed at the 0.3% on R&D, and of course, our cost of doing business was up, so like 0.6%. That's our S&A there. So that's about 0.9 of the margin difference. And then the rest of it is related to under absorption and the mix of the businesses within there.
I don't have a break of the two of them, but it does break through. What I normally do is I look at the figures. I do a quick run through my key figures there. What should the result impact have been? And it came broadly in line, and it's more driven by the under absorption, and a little, as you see, the mix between the businesses.
Just to come back on the mix-
Mm-hmm.
Were there any impact on margins from the weak performance in China?
I would say not-
in the quarter?
Yeah, I wouldn't say China so much is such a big impact in the margin, but also in, for example, the automotive business. In the first quarter last year, they had very good vehicle service market business in Europe. They didn't have very good vehicle service market business in Europe this year. So there's a little bit of a mix of that business there with it. So the mix was not huge, but it was an impact. But no, China was not a major factor in that.
Okay, thank you very much.
You're welcome. You're welcome.
Thank you very much. That brought us to the end of the presentation. If you have further questions, you're welcome to contact me. Thank you very much, everybody, for participating.
Thank you. Thanks, everybody. Have a good day. Thank you. Bye-bye.
Ladies and gentlemen, thank you for your participation. This concludes today's-