Ladies and gentlemen, good afternoon to you all, and very welcome to this conference call for the presentation of SKF's nine-month results, 2011. This teleconference will take an 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 presenting the results, and then after this, there will be a Q&A session. Over to you, Tom, please.
Thank you very much, Marita. Ladies and gentlemen, hello. Earlier today, we published our report for the third quarter of this year, and, I would say it was an interesting quarter, since it was characterized by a lot of, turbulence and uncertainty in both the financial and the political world. However, even with this turbulence, in the markets, we did not see any real impact on our business in the quarter. Our industrial businesses continued to grow at a similar pace to earlier in the year. Of course, from this, I exclude the wind business in China, which, I will comment on a little bit later, so no real impact there.
In the automotive business, we did see a slowing, but this was mainly in the light vehicle business in Europe and in Latin America, with North America continuing to develop well, Asia showing a little slower growth, but still growth. So overall, the third quarter was a very good quarter for the SKF Group, with sales increasing by 13.3% in local currencies. Operating profit increased by over 7% to nearly SEK 2.48 billion, even though we faced some heavy headwinds from currency and raw material.
With an operating margin of 15% in line with our target level and a good cash flow of a little more than 1.3 billion SEK, although I must say that that should have been a little bit better if it was not for inventory, and I'll talk a little bit more on that later. We also took a number of important steps to further strengthen SKF in the quarter, with the opening both of a new warehouse in Latin America, which will improve the service to our customers and distributors there, and with the opening of the new medium-sized bearing factory in Dalian, which is our second factory in that city, and that it will primarily focus on the industrial markets. I'm also, must say, very pleased that we maintained our membership of both the Dow Jones Sustainability Index and the FTSE4Good Index.
We continue to invest as a group in our research and development and have increased our spend by, what, nearly 27% in the first nine months of this year, as we're stepping up the innovation activities in SKF. In fact, in Q3, the increase was somewhat more, and it did affect the cost and gross margin there by something like 0.6 or 0.7 in the quarter. You'll see in our report a number of new products for the industrial market, and we're launching products in all of our markets. And I can tell you that by already, by the end of the third quarter, we've almost reached the same number of patents that we did in the whole of last year. So a real step up in our innovation activities in SKF.
This is, these steps, the investments, what we're doing in research and development, are fully in line with the strategy and initiatives which we launched at this time last year, when we also announced the new targets. Let's now go into a little bit more detail on the demand development. You'll see our volume was up some 6.2% in the quarter. Bringing in price mix, that means an organic sales growth of 8.2%. Saw a similar development in Europe, North America, and Latin America, with our sales in all these regions up by close to 10% year-on-year. The problems which we mentioned last quarter in the warehouse in Brazil are virtually over now, and there was little impact of that in the quarter. Turning to Asia, you see that it grew by just under 5%.
I'm sure you saw that as a strange figure. The reason was quite simple. As the quarter progressed, the wind energy business in China went from weak to virtually a stop for us. This is due to three reasons. One, the control of permits for new wind farms has been tightened up. Secondly, the supply of money, for the new wind farm operators to get to invest in new wind farms, has become tighter. And, of course, there was a lot of wind farms that were installed last year that are still to be connected. I did a rough calculation, and if I say, without the impact of wind in China coming virtually to a stop, our sales in Asia would have been up probably three, maybe four points better than the, than they were. Even our sales in the light vehicle industry in Asia were good.
The level of growth is easing off, and we also see some slowing signs in India for the car business. If I look at the rest of the business in Asia, then in China, we saw very good growth in our sales to the fluid power, metals, railway business, and the industrial market, and a good growth in the vehicle service market. In India, we had the same segments growing well, but here we also saw in India, a good growth from renewable energy. In other markets in the region, we continued to see a positive development, particularly in our sales to the two-wheeler market in Indonesia. Latin America, we saw good growth in nearly all our main segments, with the exception of the car business in Brazil, where customers have reduced production and also announced, reductions for the fourth quarter.
In North America, we saw a continued good development overall, with a very similar pattern to the previous quarter. And here, we've not seen any real impact from the political discussions and debt problems, which were very much in focus during the quarter. Our industrial business developed well, and the main segments of growth being fluid power, which is, you know, we call, is what we call pumps and compressors, construction equipment, agricultural equipment, and mining equipment. Sales to the renewable energy sector in North America have stabilized, but they're at a low level. We've a very good development in the Service Division with our distributor sales going well, and automotive business, our sales to the light vehicle industry developed very much in line with our expectations.
In Europe, our strongest growth from an industrial viewpoint was to similar segments as in North America: fluid power, industrial gearboxes, agriculture equipment, construction equipment. Aerospace business is also showing a good, steady, positive development. In Europe, our sales to industrial distributors are developing well, and we're seeing some improvement in the activity within the renewable energy segment in Europe. I expect it to slowly improve as the year goes on. But sales to the car industry in Europe were lower, as we expected going into the quarter. While we had a very strong growth in our sales to the truck industry, it is clear that sequentially, they've stabilized. The recent news from the truck industry in Europe shows its peak, and we'll see it edging down as we go forward to the fourth quarter.
So overall, good volume development in the second quarter if I exclude mainly the wind business in China and the somewhat weaker car business in Europe, Latin America. For the first nine months, our sales are up organically 14.4%, if I include Lincoln, which I must say, continues to develop very positively and according to plan. We're up 19.2%, including Lincoln. Could I comment here that and say that we're integrating Lincoln more and more into SKF, which means that in most of the main markets, all the sales for lubrication systems, for both the OEM and the aftermarket, are handled by the Industrial Division. And in the other markets where the Industrial Division is not present, they're handled by the Service Division.
That means the majority of the business is in the Industrial Division. This covers not just the Lincoln business, but all our lubrication business in total. Let me turn to manufacturing. Our level of manufacturing was higher compared to last year, but we started to reduce it, particularly in September. It was not enough to help us cut back in inventories, both of finished goods and also of incoming materials. So our inventories went up a little, even excluding the currency impact, and that is clear we have to take steps to reduce these inventories in the coming quarters. Let me turn a little bit and talk about the profit development. We continue to face higher raw material costs, much higher than last year due to higher base prices and surcharges.
However, as you've probably seen, the scrap price has gone down a little recently, but it still remains over 20% higher than the average of last year. It will be interesting to see how raw material prices develop in the coming months, although if I read the commodity outlook from some independent agencies, it says it will remain at high levels. We have been able to offset the higher raw material prices in the quarter with the same three actions which we've used before, and I will not go through them. One of them, of course, is pricing. You'll see a positive price mix in the quarter of 2%, helped by the... A little by the mix between the divisions.
If I look forward on raw material prices, just to let you know, we've not started our discussions in details yet for next year. But, it's interesting that the first indications, also from suppliers, are that they expect price increases. We don't plan to start detailed negotiations for a month or so yet, so I cannot give you any views on how this will finish at this moment. Operating profit, SEK 2.479 billion was strong, giving us a 15% operating margin in what, of course, is a summer quarter when some of our manufacturing operations are closed. I think this shows that we have reduced our cost base in SKF. We're getting the benefit from the higher volume and the launch of new products to the market.
We're getting, w e're delivering more value to our customers and getting paid for them. We now have an operating margin of 15.2% in the first nine months. And I must say, when I launched the new targets virtually one year ago, I didn't expect to be running in line with them already now, so I think our team have done a great job. A few comments on the divisions, maybe. The Service Division had the best development. It's got a good margin, 15.6 operating margin, and they saw the strongest sales growth, up some 12%. This was, for Service Division, very broad-based, very broad-based across all the, all the regions for them. The Industrial Division had a very good development.
I think they had a 7% growth, especially if you take the impact of the wind in China on them, and a 12.6% operating margin. I think it is important to note, when you look at the Industrial Division, that they had a somewhat negative mix in their volume due to what happened in China. And also, they carry the largest percentage of the negative currency. Automotive Division saw the weakest growth, with sales only up just over 3%, and here we saw some cutbacks in demand, especially at the end of the quarter from car customers. And of course, we also continued to see a weak development in the vehicle service market. This meant, as I said earlier, we started to lower production, mainly in the Automotive Division in...
At the end of the quarter, and they also started to reduce temporary workers in their operations. Our cash flow was good in the quarter, but as I said earlier, not as good as it should have been. We built some inventory, which was not planned to do, but was a direct result of both the cutbacks from our customers, which happened at fairly short notice, and the fact that we, although we lowered production, we couldn't stop the incoming supplies quickly enough. So if you had asked me one thing I'm not happy about in the report, I would say it's inventory development. Let me move on now to the outlook for the fourth quarter, since I'm sure that that is the most interesting point for you.
I must say, it's been a really difficult outlook to make this time, since there is a lot of uncertainty in the market. But I've got to say, we do not see major signs of change in the order intake from our customers and their information to us, especially if I exclude the four segments of cars, trucks, railway, and wind, wind energy. In all the other segments, which are mainly the industrial segments, we don't see any weakening demand from our customers. Let me look around the regions then. We think Europe will be somewhat down sequentially, and even a little bit lower compared to last year. And you may say, "Why?" Well, it's due primarily to the weaker demand in the Automotive Division.
What we see in the Automotive Division, primarily the car business and the truck business, where we see it going down, and still a weak vehicle service market. Our industrial business in Europe is still at a good level. I think that Europe, and especially Western Europe, is showing signs or some signs of weakening. As I say, we see it in automotive. So I'm quite, let me say, pessimistic for the business development going out to this year in Western Europe. Let me switch to Asia. Here I see no real change from the level we're at just now, even with a continued expected weak demand in wind energy business, which means, a slight growth year on year, but really running at the same level as it is just now.
Over to North America, we're working at a very good level just now, and I see that continuing, but it does mean it will be unchanged, when I look at North America, both sequentially and year on year. In Latin America, it will be slightly up even, both year on year and sequentially, even if I see a continued weak car business in Brazil. Per division, there's a few comments on that. The industrial businesses will continue to be good, I think, and they'll operate at a good level, probably leveling off sequentially, with the best development year on year being in the Service Division, where I still see them continuing to develop positively. This is due to the geographical coverage that they've got, the fact that they've also got the service business and the fact that they serve a variety of different industries.
The Industrial Division, for me, seems to have leveled off sequentially, but I still think it will be a little bit up year-on-year. Because if you look at it, they'll have wind down sequentially, but I also think it wind down sequentially, which is primarily driven by China. But I also would say that you'll see a somewhat lower railway business for the Industrial Division, again, due to weaker demand in China, as they're not gonna be ordering so much freight cars, it seems, in the fourth quarter. For other industrial segments, we see demand staying at this good level. As you would expect, Automotive Division will see the weakest development being slightly lower sequentially, but also lower year-on-year.
This, as I said earlier, is due to the demand in trucks being down lower, cars, and a still weak service market. Overall then, for the group, we see demand in the fourth quarter being. Well, I mean, when you look at the group in total, we see demand being relatively unchanged as last year, which means coming down sequentially. However, I say again, this has been very difficult to forecast this time due to the different pictures from our different customers and the fact it's changing all the time. From a manufacturing viewpoint, we're bringing down the manufacturing level from the third quarter to both meet the lower demand expectation and to start to reduce inventory. We will also have a lower manufacturing than in the fourth quarter last year. The main reduction in manufacturing is important.
You will see that in the Automotive Division. You must remember, though, as we're bringing down manufacturing, one of our key priorities is to improve our service level to our customers. So we'll be careful when reducing production, not to hit the service level. Please remember also, when you look at that, when you break production like this in a short period of time, you carry a lot more cost. A lot more of your costs are fixed, and you need for the production level you have. So it does have some impact, short-term impact on your cost level and, of course, your results. We saw that in 2008 also. With that, I think it's a good time to maybe focus on what we do if the demand continues to weaken, which is a fair question, and I'm sure you, you have.
Please remember that we've taken a number of steps over the year to make ourselves more robust and more diverse. We've divested component manufacturing, reduced our fixed cost, reduced our working capital in our business. We've been increasing our manufacturing footprint in what we call best cost countries, which is closer to our customers, and this we will continue to do. We've also worked hard to diversify our growth with more value-added products and more of the business in faster-growing regions and segments, and made some important acquisitions to strengthen mainly our industrial business. These steps were made during a long period of time, and I really believe we're now more robust and diverse in the business, and I think that helped us a lot manage the last big downturn.
But I'm sure one of your questions is, Tom, what would you do if there is a more significant downturn now? I think it's a good question and the right question. I can say we learned a lot from the last downturn a couple of years ago, and have a number of activities already underway to be able to be prepared and operate in the event of a big downturn. We have a program we call 3C, which stands for customer, cost, and cash, and that's already been re-emphasized in the group. We're stepping up our presence in the market with more customer visits, improved service level to our customers, and a strong focus on the faster-growing regions and segments. We're continuing to invest in our research and development as well, and continuing to launch new products and solutions to the market.
Of course, the other Cs are important as well. So we'll reduce cost by cutting back a lot on discretionary spending, internal meetings, travel, consultants, et cetera, et cetera. We did that last time as well, and of course, cash is very much in focus. From a manufacturing viewpoint, we will reduce, and where necessary, eliminate overtime and use the number of flexible schemes we have. We can also reduce the number of temporary workers that we have. We have over 4,000 in SKF just now in our manufacturing, and of course, the government schemes are still in place if we need them. I really think that we have the toolbox to address a downturn of our business if it comes, and be sure we're well prepared. Let me close now by giving you some financial input to help you look at the fourth quarter.
Financial net, around SEK 175 million. Taxes, around 30%. We'll have a negative currency impact in the fourth quarter compared to the fourth quarter last year of SEK 100 million, which is a little better than we thought a few months ago, due to the stronger dollar, bringing the full year impact down to SEK 1.2 billion. Our forecast for additions to plant and property will be a little bit less than the SEK 2 billion level now. So let me try and close by giving you what to look at when you look at the fourth quarter. Let's look at it. Our sales in the fourth quarter is gonna be relatively similar to the fourth quarter last year, but our manufacturing will be lower.
We have higher raw material costs and a negative currency impact, but I expect a positive price mix to continue. I would also take note also of the fact that we've stepped up our investments in research and development. As I mentioned earlier, it was a lot more in the third quarter, and it's roughly 0.3 effect on gross margin year to date, is the increase in research and development. That we will continue with. Remember, also, we'll have some impact of the fact we're braking production from the higher level in the third quarter as before. So in closing, third quarter, another good quarter for the group. Good sales development, good operating margin, and we also continued the steps to invest in our business.
New operations in Latin America with a warehouse, new manufacturing in China, launching of new products, and stepping up our spend in research and development. This will support our long-term profitable growth and initiatives. Now back to you, Marita, and then over to questions.
Thank you very much, Tom. Now it's time for the Q&A session. Please go ahead.
Thank you. Ladies and gentlemen, if you do wish to ask a question at this time, please press star followed by one on your telephone keypad, and it's the hash or pound key to cancel. Once again, that's star followed by one if you wish to ask a question, and it's the hash or pound key to cancel. The first question comes from the line of Fredric Stahl from UBS. Please go ahead.
Good afternoon, Marita and Tom. It's Fredric here at UBS. I just had a quick question, if you could possibly quantify the amount of inventory you can take out of the business in the fourth quarter, or if you can give us a range to get us a feeling on what the capacity is there. Thanks.
Thanks, Fredric. I don't want to give an exact figure, Fredric, but we do intend to cut back quite a bit in our manufacturing there. So we put a few hundred million in the third quarter, and we will work to take that sort of level and a little bit more out in the fourth quarter, but I don't want to give you an exact figure.
No, that's perfectly fine. Thank you very much.
Thank you very much, Fredric. Next question, please.
The next question comes from the line of Nico Dill from JP Morgan. Please go ahead.
Good afternoon. Nico Dill from JP Morgan. I have three questions, please. First of all, on the Asian sales in the Industrial Division, you highlighted sales were down significantly in this, in this subsection. Could you highlight how much sales are down outside renewables in the Industrial Division in Asia? Second question is around, effectively applying the brakes here. Inventories were up a little bit. You're applying the brakes now. Since you've started to apply the brakes, as the end environment gotten worse, effectively, is the underlying question there. The third question is around the automotive margin, both year on year as well as sequentially, down quite heavily, quite a high drop through. Could you give us a bit of flavor of whether this is sustainable or how we should think about that going forward?
Yeah. I would say if you exclude the wind business for the industrial business in Asia, and the industrial business was up, excluding the wind business. A good development there. It was the wind business that brought them down there in total. So excluding that, good development in the other areas. And I would say also in markets like China, we saw good development in all the other segments we supplied there. It was the wind business that was affected. Even the railway business in China in the third quarter was very, very good there. It was the wind business that affected them down there, and the wind business in China, because wind in renewable energy in India was good.
In terms of has the end market environment got worse since we started to apply, I mean, we're applying the brakes or reducing our production right now in a number of areas there. And I would say that, especially in the automotive side, you—and I mean the automotive by cars and trucks, you're getting some new news all the time there, so we will keep breaking that as we go forward there. So it is a little bit changing. And I, and I would say if you actually look at the car business outlook and the truck business outlook that we've got, and you compare it with some external market data, you'd see we're a bit more cautious, quite a bit more cautious than some others.
That's because we see, starting to see some signs, that we don't think that's really taken account of in external market forces, or let's say forecasts. In terms of the Automotive Division, yeah, I mean, I think they're affected by a couple of things. One, the mix of their business, as I say, cars came down with them in Europe. Also, the vehicle service market in Europe was weak for them. So it was a... They had a mix effect on that. Going forward, as we keep production down, industrial, we're not really bringing production down much a bit. We're bringing it down, but not a huge amount. Where we are bringing production down significantly is in the automotive business.
So in the fourth quarter, the automotive will be hit much more by the fact that it sees lower sales to the car industry, to the truck industry, similar to the weak vehicle service market, and we're bringing the production down more in that area.
Very clear. Thank you.
Thank you, Nico.
Thank you, Nico. The next question, please.
... The next question comes from the line of Ben Uglow from Bank of America. Please go ahead.
Yeah, good afternoon, Tom, Marita, it's Ben at Merrill Lynch. Two questions, please. First, just on Chinese wind. I mean, you said the market had basically stopped, so can it actually get worse from here? And how long do you think it will take for the market to pick up, given, you know, lack of kind of T&D capacity, financing, and permits and so forth? And then secondly, I think your pension liability increased during the quarter. Maybe if you can, just run us through the move. Does that fully reflect the changes in interest rates and asset prices that we've seen? And then finally, just on the auto business, can you just clarify the mix effects? Are there negative mix effects in the auto business, in terms of OEM versus service?
I guess on the OE side, the emerging market demand versus European U.S. demand, are they material or it's more about the volumes going through the business? Thanks.
Yeah. I'll take the last one first, the automotive. It is, of course, a little bit to do with the fact that we're starting to break down the production, but it is to do with the fact that the vehicle service market, especially European vehicle service market, didn't perform so well, and then a little bit the mix in the car business between the different regions.
There we go.
If I go back to the wind one, Ben, when it's stopped, it can't get much worse than stopped.
Sure.
Yeah, but to be honest, Ben, I think it will continue for some time.
Okay.
As I said earlier, I think it's a factor of two... three issues. One, the fact that the way permits were issued in the past were primarily local. They were not responsible for wind farms below a certain size. They could do it locally. That there's new rules and new ways of handling that being centralized. Secondly, the, as you mentioned, the liquidity of funds, et cetera. And thirdly, quite a bit of the installed capacity that was put in place last year. If you remember, that of the total megawatt capacity that was installed last year, 50% of that was in China. Quite a bit of that's not connected yet.
Yeah.
I think it will take some time, a few quarters, to go through, to be honest.
Okay, thanks.
Thank you, Ben.
The pension liability is totally okay.
All right.
Yeah, this is Tore Bertilsson.
Thanks.
So on the pension liability, in the balance sheet, you'll find the change of the liabilities as such, the net liability, which consists of assets, of liabilities, less plan assets. And there is a currency effect, a translation effect, to start with, but you will find on page nine in the quarterly report, the actuarial gains and losses, which are roughly SEK 1.3 billion in the quarter, and that's made up of two things, of course. First part, the biggest part is the change of discount rates. When discounting the pension liabilities at low rates, you get a higher nominal amount, of course, and, of course, also a loss on the asset side there. We do these actuarial valuations every quarter.
Some companies use corridor methods, et cetera, but we do them each and every quarter, which will be mandatory under IFRS going forward. So you will always find the changes there under the actuarial gains and losses.
Great. Very clear. Thanks, Tore.
Okay. Okay.
Thank you, Ben. Next question, please. The next question comes from the line of James Moore from Redburn. Please go ahead.
Yes, good afternoon, everybody. It's James at Redburn. Three questions, if I could. One on the unallocated below the divisional line, which has been -70 on average for three to four years, and negative number every quarter for three to four years, and that's just popped up to +63. I'm sure it's just the usual items, but is there anything within the usual items that's driven that positive number? And then on the inventory to sales ratio, are you thinking that we drop back to something like 21%-22% then in the fourth quarter, not back to the 20% level?
And then finally, on the automotive margin, I didn't quite understand within the car side, the OE side of the business, is there a regional margin mix issue, and which is the better and the worse margin side of that, which has affected it?
Yeah. Okay. The unallocated is the usual reasons, and actually, I think if I look back over some of the quarters, and I don't have the details with me, there have been other quarters over the last three, four years where it's been positive, but I don't have the facts in front of me, James, so I will check that there. But there's no special reason. It's the usual reasons there, and you do see it when you see some big currency changes there. In terms of inventory to sales, I do not think we can get back to 20% by year-end, and that's not realistic. But I think we can reverse the trend that we've seen in the last couple of quarters within that there. So we need to reverse that trend. The...
In terms of the car mix, yeah, it is to do with regional mix. There is slight differences between the different regions, which affects them from a sales side, but also from a manufacturing side as well, as we break the production a little bit more in some areas there. So it is, there is a little bit difference in each of the areas, and that did affect them as well. But the bigger effect in automotive was the fact that the aftermarket was down.
Given the complexity of that automotive margin story and some of the issues you've highlighted, notably production, can you help us a little bit about how we should think of the second half or the fourth quarter automotive margin? I'm scratching my head a bit on that one.
I'd say it's a good thing to scratch your head on, James. No, but really, I think what you're going to see, as I say, you're seeing the truck business, we're seeing that go down. And that is a good business for the Automotive Division there. That's primarily European business. In the car business, we expect to go down for us as well, and the VSM to stay weak for them, and we're breaking the production quite significant. So it will have some impact on its margin, to be clear, in the fourth quarter. And again, as I said in my opening remarks-...
The one thing to remember, as we saw 2008, as you've seen before, as you know well, that when you break production quite a lot of your costs are, at least in the first couple of quarters, or at least the first quarter, are much more fixed than they are variable. So therefore, you break the production, and you don't get the cost out. So we'll have some impact on the margin in the fourth quarter, quite a bit.
Okay, thanks a lot.
Thank you, James. The next question, please.
The next question comes from the line of Arnaud Brossard from Exane BNP Paribas. Please go ahead.
Hello. A few questions. First, on raw materials, please. You had a headwind in Q3. Could you please help us get an idea of what the magnitude of this headwind was, and what effect do you expect in Q4? That's my first question. Then, on your outlook for the fourth quarter, does it reflect the current trend in demand, or is the flat expectation year-on-year, the reflection of your expectation of where demand is going?
I think, I think the second question is an excellent one. Let me take the first one first, though. Raw material. Raw material, I mean, we don't give the figures out exactly what's happening in raw material, but the headwind, what, what you see is there's a couple of quarters gap between us seeing the higher raw material prices, especially on scrap surcharges, et cetera, and it coming through into our income statement. So I would say third and especially fourth quarter are the higher periods for us in terms of raw materials, because although raw, scrap prices have gone down a little bit in the past, couple of months, we won't see impact of that in our surcharges until into, into next year as well.
But I can say that with the steps we've taken with pricing, with the steps that we've other steps we've taken, we've offset the raw material cost, but I don't want to give the exact figure there. In terms of Q4, it is a combination, especially in the car and truck business, I would say the automotive. It is a combination of the news that we're seeing, because we have seen and we are aware of the cutbacks that have been made. There has been, for example, in Brazil already, the three main manufacturers, three of the main manufacturers down there cut back production at the end of September. They've already announced cutbacks in October. There are cutbacks in a number of European vehicle producers for the fourth quarter already being announced there. You've seen in the...
If I look at the truck side, you already see announcements from companies like, for example, Scania, and what they are doing to reduce things. So there are things that are in there, and based on what we see in there, there is also a step where to say that we believe that others will be affected, therefore, we've taken a judgment on that as well. As we do every quarter, it's not just we cannot just run what we see in the order book. We have to run on what we see in the order book and our expectation based on how we see the trend developing. So it is a combination of what we already see in our order book, especially in automotive, and what our expectation is.
I think particularly, that will be interesting to see what happens round about December and round about the Christmas period there. Do customers stop somewhat earlier than normal there, and do they last much longer afterwards there? So it is, it is a combination of what we see and what our expectation is extrapolating out, that if it's affected some, it could affect some others.
I see. Thank you. And one final one, if I may. On inventories, they increased, I think, more than you expected. Is it the reflection of the fact that Q3 was, the demand was, in fact, weaker than you expected?
Yeah, I think that if you look at it, yeah, it did come up. Half of the increase, roughly, in the quarter, was due to currency. Half was the sort of volume, if you take it roughly, there. And it was due to the fact that towards the end of the quarter, particularly towards the end of the quarter, we saw some things easing off quite a bit. I can tell you, the growth in September, year-on-year, percentage-wise, was lower than the growth we had seen after the first two months of the quarter. So it was, it was easing off, especially in September. And that, that takes you...
When you see that happening, especially short-term shutdowns of customers in the automotive side, plus you've got goods coming in from different suppliers, et cetera, that quarter is delivered by the end of the quarter.
Okay, thank you.
You're welcome.
Thank you, Arnaud. Next question, please.
The next question comes from the line of Guillermo Peigneux from Morgan Stanley. Please go ahead.
Hi, Tom. Hi, Marita. Guillermo Peigneux from Morgan Stanley. A couple of questions. First, on your inventory to sales target, which has been 18% for a while now. And I'm wondering, I mean, this ratio, well, if we look back to 2008, at the, like, second quarter 2008, then the third quarter 2008, it shot over because of a variety of reasons, mainly, currency. And we see now the currency is also a big portion of of the increase here. And I'm wondering whether, actually, despite efforts on, inventory reduction, you're gonna see actually inventories, moving up, in relative to sales as we progress, through 2010 Q4 to 2011, and probably beginning of 2012.
And therefore, well, a degree of, in a way, a degree of more inventory cuts needed, in order to, to be consistent with that target, or is that target becoming less and less meaningful since, it hasn't been met since the, the beginning of 2008? And then, second, basically, when talking about temporary workforce, could you sort of put in context how much of your headcount was temp back in 2008 or mid-2008? How much of your headcount is now temporary? And then secondly, looking at the environment at the moment, trade unions and governments may be a little bit less proactive this time. Would you think that is gonna be the counterpart on those negotiations is gonna be more-...
Regarding retaliation towards any actions taken? Thank you.
Let's go through them. Well, a few questions there. Inventory, I don't think the currency will have a big impact on the inventory in the fourth quarter, from my viewpoint. Let's see how it looks going forward there. Secondly, is the target meaningful? As you rightly point out, we actually have never hit that target. We didn't get... We got close to it. I think in one quarter, we've never got down to it yet. Do we still believe it's meaningful? Yes, but it does require fundamental changes in how we're doing things. So it is one where we have put a major effort in over the last few months, and it will take a little bit of time to get the efforts out there or the result of these efforts.
But it is a meaningful target, but I don't want to set a date when to achieve it. But to reverse the trend is clearly on our agenda. In terms of temporaries, we have a little bit more than 4,000. I think it's about 4,300 temporaries in SKF at the moment. And we've taken about 250 or 250 have left so far, as a result of the steps we've taken to pull back production there, as well. So these are steps. I don't have, off the top of my head, the figure on temporaries, how it was in 2008, 2009.
My gut would tell me that we're a little bit higher in temporary just now than we were then, but I've got... I don't have that figure, to be honest. I'll try to dig that out, Guillermo, there with it. Regarding the steps, if we have to take steps to reduce production, I think we had an excellent support last time from workers, and of course, we had the government-based schemes. I must say, I do not expect any different in support from our people at this time, in order to use flexibility in doing things. Because I think the issue will be to find ways to do flexibility in terms of reducing the number of hours without reducing the head, using short-term agreements, bilateral short-term agreements, et cetera.
I've got to believe that, and I do believe from the discussions I've already had, that we would get the similar type of support. Then the question you could ask is, would the government schemes continue to support us? I would say that the government schemes, especially in Germany, et al, et cetera, these government schemes are in place to try and support over a period of time, companies manage a change in demand situation. And they're actually more... They're a win, win, win. A win for the government because it costs them less to support these schemes than it would to support unemployed people.
It's a win for the employee because it's just part of the company, we can invest in training with the employee, and it's a win for the company because we don't need to permanently reduce. We keep the competence in SKF. We continue to develop the competence in SKF. So, at the moment, from the feedback I have, and from the discussions we now have, I still think the scheme will be supportive of us if and when we need to use them. The first step that we're doing just now is addressing temporaries, is addressing overtime as well. Remember, we have overtime. We've been working on overtime for some time. These are the first two steps that we'll address, and then let's see how we do going forward.
Thank you. Maybe one last on when it comes to priorities, would you say that now inventory reduction is a priority over, let's say, production or margin stability going forward? Just to reconfirm that, you would expect, despite seasonally stronger margin, or you would expect a Q4 number in terms of margins that is weaker?
The service level is our priority to our customers, to make sure we give the right service level to our customers and do that with the lowest amount of inventory possible. So we will not sacrifice a service to get the inventory level down. We must give good service to our customers. As I said earlier, our first step we're doing is increasing our activity level in the marketplace. So our priority will be to deliver good service to our customers, to make sure we don't lose business in the market due to the fact we can't deliver service, and then to do that by step by step, taking down our inventories, there.
Thank you very much. Very helpful.
Welcome.
Thank you, Guillermo. Next question, please.
Once again, if you do wish to ask a question at this time, please press star, followed by one on your telephone keypad, and it's the hash or pound key to cancel. The next question comes from the line of Martin Prozesky from Bernstein. Please go ahead.
Good afternoon, everyone. It's Martin from Bernstein. A few questions, please. The first, Tom, on price mix, you mentioned interdivisional mix had a impact. Can you just give a sense of how much? Was the mix really significant, or was it mostly pricing coming through from previous increases? The second, on your auto margin sequential weakness, was that mostly cost under absorption? Was there also kind of a mix as truck weakened? Was there also a mix effect in that margin? And then thirdly, on European renewables, surprisingly, you said there's some kind of strength there. Is that really just signs of life from a really low level, or are you seeing the demand in that business normalizing?
I take them first. I would say the interdivisional mix is around, it's difficult to get the exact figure, but around 0.5 point, 0.5, roughly. Interdivisional mix was the positive impact on the price mix. The rest of it was due to pricing actions we've taken before, and then just the normal mix in the business with the new products coming in. In terms of the Automotive Division, there, it was a combination of factors, but it wasn't just a mix of OEM, it was the fact that the vehicle service market wasn't growing the same way as the rest of the business, and especially in Europe, was lower. Yeah, so that had an impact, and of course, the vehicle service market is more profitable for them. So that was that impact there.
And we switch to renewable Europe. Yeah, I would say renewable Europe has been down for some time for us there. So, signs of it improving from the level that it's at. It's not back to normalized levels yet.
Thank you.
Thank you, Martin. The next question, please.
The next question comes from the line of Peder Frölén from Handelsbanken. Please go ahead.
Yes, good afternoon. Tom, you have to take me through your guidance again. You're talking about sales being flat year-on-year in the fourth quarter. At the same time, we talk about slight decrease in volume sequentially. I guess there's some seasonal uptick in the fourth quarter sequentially, which means that if volumes are down slightly, they should be sort of less than slightly down if you take into the seasonality effect, and on top of that, you have structures. So I have a hard time seeing that sales would be equal to the fourth quarter, 2010. Could you just clarify if it is sales or volumes that you are talking to? That's my first question.
First of all, structure is excluded from this.
Sorry?
Structure is excluded, so that means when you look at the Q4 figure, you should add back in structure.
But it's price mix, it's volume, and it's FX.
It's volume, it's volume and price mix.
Only organic. Yeah, that's very, very clear.
Okay.
Good. Okay, on profitability then, maybe you could help us out here, to... I mean, the fact that you had a decent factory load in the third quarter, building inventory, that should have helped your profitability somewhat. Is that possible to quantify by any means? And also, of course, when that is reverted coming into the next quarter, how much sort of the factory load in itself, not only the breaking as such, but actually the load could affect profitability Q on Q.
Yeah. I think it's a good question. I looked at actually doing it the other way around, but rather than fourth on third quarter, that I looked at fourth quarter on fourth quarter last year.
Yeah.
If you do it that way, how I would walk you through to look at the margin. The volumes will be similar the two years. Secondly, production will be lower in the fourth quarter this year versus the fourth quarter last year.
Yep.
Thirdly, you will have a positive price mix. Fourthly, you will have a headwind, a little bit headwind of currency-
Yep.
and a headwind of raw materials there. You can calculate and how you can see these things come along.
Mm.
We will get a little bit benefit, of course, by having Lincoln in there this year versus last year, because that's outside of these organic checks there. But on the other side, we will be spending more in research and development. As I said, year to date, we are spending about 0.3% of sales, which is seeing COGS higher. In the third quarter, actually, it was 0.6%-1.0% higher compared to last year in that page. So that's another headwind, and that's something we'll not ease back on, we will spend a little bit more. So these are the factors you should take into account, Peder, when you look at the fourth quarter.
Okay. And on the seasonality, how much was the seasonality in the third quarter? If I do the math correctly, volumes were down, like, 7% Q on Q. And I guess you had some seasonality in that, and I am surprised if that was more than a couple of percent. So... And how much is the seasonality in the fourth quarter helping volumes normally?
You're right. The seasonality in the third quarter is less and less. It is becoming less and less the seasonality impact on SKF in terms of sales. And why is that? Because as we grow our sales outside of Europe, particularly outside of West Europe-
Mm
... then you, then you're into areas which don't have the same seasonality, there, in total. So the seasonality switches out a little bit. I think the thing, looking at the fourth quarter versus the third quarter, normally, it has a very little positive seasonality in it. But I think this year, particularly also, you gonna have to look at the fact that the, I think there'll be more impact around Christmas this year, than the normal, years.
So little seasonality uptick in the fourth quarter, if I read you correctly?
I would not put much in at all for that one. It's marginal, to be quite honest, Peder.
Perfect. I think final question then for me, restructuring. Usually, in the fourth quarter, we have SEK 200 million, and I guess that this would be a good opportunity to take out some more fixed cost in the automotive side. Could you help us out here and shed some light on your thoughts?
Yeah, I mean, it's clear at the moment, we're trying to see exactly what's happening to demand situation in there. We remember in automotive, we took a lot of steps to take restructuring in the last downturn-
Mm
... and we've done quite a lot in that area. We don't have any plans for big things in restructuring. There may be some things in the fourth quarter, but there's no big things in the fourth quarter just now. We, we would like to get a better look at how we see the demand situation, going into next year, and then take the steps that we would, not just for next year, but for the year after, take the steps that we need to take. So there may be some, but it won't be significant in the fourth quarter, as we see it just now.
Okay, I'll get back in line. Thank you.
Thank you.
Thank you, Peder. Next question, please.
Next question comes from the line of Sebastian Growe from Société Générale. Please go ahead.
Hi, good afternoon. Two questions, if I may. Coming back on Asia, I mean, you mentioned 8-9% organic sales growth without the wind energy segment, but it still represents a major slowdown compared to the 17% growth you achieved in Q2. So I would like to have some more color on this slowdown. The second question would be, could you give us the breakdown of the FX impact on profit by division, please? Thank you.
If you take the Asian growth, it's clear that, and we highlighted that, over the last couple of quarters, that the rate of growth in the Asian region would start to come down, somewhat. And that, I think, is something that we expected going forward there. What you do see in the Asian region is, if you go into markets like China, you see some areas easing back in terms of growth, while other areas are going well. I mentioned, for example, wind energy, but we can also see going forward, railway will be somewhat weak. You can also see we see in India, the rate of growth not quite as high now as it was a little bit earlier. There although we still see good growth in India.
So it is a combination that the rate of growth is easing back a little bit as the government steps to address inflation, to address money supply, taken back there. And also, we're, we're against some very, very tough, comparisons there. So I, I, for me, as I said, I think, it's, we expect the Asian growth to ease off somewhat going forward. In terms of FX effect, I would say, do a quick count of, of, of the FX effect on the divisions. I would say around 60% or so in the, the Industrial Division, affects the Industrial Division. Then between, automotive and service, it's split, but maybe a little bit more to the automotive, but just a little bit than, than to service. But, you know, 20-25 automotive, 15-20 service in that area.
Just to be clear, I mean, the FX impact at the divisional level, it's SEK 400 million, there is nothing in the corporate line?
No.
Okay, thank you.
Thank you very much. The next question, please.
The next question comes from the line of Lars Barrlin from RBS. Please go ahead.
Hi, Thomas, it's Daniel Sheridan here. Quick, quick, two questions. Firstly, just if you can just give us the sort of FX-adjusted inventory number. I know you usually do that most quarters. I think you said it was half of the increase was due to FX, which just gives us that adjusted number, would be helpful. And then secondly, on service, just really interested to see how volumes were developing here in the second half or into the second half of September, because obviously, that number from a volume was pretty solid. But it's interesting to see how that sort of has developed as you sort of move through, especially to the back half of the quarter. Thanks.
I mean, Service Division held up very well throughout the quarter. No, no, no change in the Service Division throughout the quarter at all. Where we saw the definite ease off was in the segments I've mentioned before, wind, which was weak in the first part of the quarter, versus, I say, going to a stop, and also the especially car business, Latin America, car business, Europe, we saw effects in that. So no, no, Service Division wasn't there at all. In terms of the FX effect on inventories, I think the increase was some SEK 700 million or so, and roughly half of that was FX, and the rest was linked to build, real build.
Okay, very clear. Thanks very much.
Next question, please.
The next question comes from the line of Mats Liss from Swedbank. Please go ahead.
Yeah, hi. Mats Liss, Swedbank. Yeah, just a couple of follow-ups, I guess. First, regarding the manufacturing level, have you expected to be lower here in the fourth quarter? And just, well, would like to... If it's the daily production you're talking about, there. That's the first one, please.
In both daily production and total production.
So the total production in the fourth quarter is, well, lower than the third quarter?
Total production, absolute amount is lower in the fourth quarter versus the third quarter, and lower in the fourth quarter versus the fourth quarter last year.
Thank you. And then about price mix there, should we expect it to improve since automotive is the mix is improving? Is that right?
It's a very good question. I think it's difficult to judge. I mean, clearly, we'll keep driving on price mix. Will it get somewhat better? Let's see, going forward. It depends really on the mix of business within the, primarily within the Service Division, how it sees its growth there. I think would have an impact if it sees more of OEMs still developing well versus aftermarket there with it. But we still expect to have a good price mix. Will it be going to get much better interdivisional? Difficult to judge.
Yeah. And then about the VSM market there, is it a, well, matter of distributor inventories being too high, or is it another?
I think there's a number of factors in the VSM in Europe. That's one impact. At the end of last year, beginning of this year, I think the distributors did a little bit too much anticipating a better market. I think the general market is somewhat lower, for us, et cetera. So there's a number of factors round, roundabout. You know, VSM, to me, is one that normally is fairly resilient for us. So, even in the last big downturn, we saw a drop-off in VSM for a little bit of time, but it was marginal drop-off, and it came back much better. So I expect the same to happen this time.
Okay. And finally, just about pensions there. Just to give me... Is it rebalanced every quarter? So we shouldn't expect anything more now in the fourth quarter if things stay about the same here?
If things stay exactly the same, there shouldn't be any change. It's done every quarter.
Okay. Thanks a lot.
Thanks so much, Mats.
Thank you. Thank you, Mats. Next question, please.
... We have a follow-up question from the line of Ben Uglow from Bank of America. Please go ahead.
Yeah, thanks so much. A couple of follow-ups, if I can, Tom. I'm firstly, just, you know, I guess everyone's focusing a little bit harder on weaker news right now. So maybe can you talk a little bit about which end markets still look strongest to you, you know, where growth momentum is good, either geographically or by segment? And then on the Auto OE side, can you just say a little bit, is the destocking that you're seeing focused on, you know, certain regions, certain OEMs, or certain vehicle types, or would you expect it to be fairly broad-based as we go into Christmas? Thank you.
Yeah. I'll take the second one first, the Auto OEs. It's, if you look at it, it's the smaller, medium-type vehicles that you see affected, and that's where you see them much more in Europe. So you see the Southern European manufacturers more affected with lower production and setbacks. There's still long lead times on the bigger vehicles, yeah.
Mm-hmm.
Similarly, you see down in Brazil, it's the smaller vehicles affected there. So I'd say it is, it is a difference between the type of vehicles.
Okay.
In terms of positives, I mean, I would say the interesting thing is, you rightly point out, we focused a lot on the negatives, that cars or trucks or energy and railway. But if you actually look at it, we've moved our industrial business up to a good level, and it's staying at a good level there. Even with all the negative news out there, we don't see signs that that's anything's happening there. Our aerospace business continues to develop positively, which I think is important. And if I exclude the energy business down in Asia, I think... And exclude the somewhat lower growth in automotive, we still have some good growth in the Asian region, with good growth in the Latin American region as well.
So I think there is some good areas out there. We see a few things which is mainly automotive-related, energy-related, but the other areas are still developing quite well. I think as well that we have a good opportunity, even despite this uncertain macro environment. We have a great opportunity with the investments we've made, with the new products we're launching in the market, with the service business that we've got to perform even better than a macro marketplace there. So we will be pushing that hard, which is why we push this program we call 3C. It's why we're stepping up our activity level in the customer end, et cetera. It's why high service level to our customers is important.
Right. Thanks, Tom.
Thank you, Ben.
And, thank you very much. And now we have time for one more question. Please. Now we have a follow-up question from the line of James Moore from Redburn. Please go ahead.
Yeah, Tom. Hi, it's James again. You mentioned that your automotive production forecasts are perhaps more conservative than some of the industry players. I wondered if you could share with us how we should think about or how you think about production levels in Europe, U.S., Asia. Secondly, I want to ask on the Lincoln margin. I had SEK 150 million in for the quarter. I know you don't bridge these things, but it's quite a big contribution. Is something like a 20% margin still accurate? And finally, can you help us at all with the margin of wind in China? Is it double? Is it treble? Is that a very big part of the impact?
If I take Lincoln. Wind, I don't want to give you that. Wind is good business for us there, so it has an impact on them. Lincoln margin, including the PPA, et cetera, is a little bit more than what you said. It's more mid-teens, a little bit above mid-teens there for us. In terms of the automotive side, if you look at the external market, I think the external forecast I've seen shows that Q4 versus. Take Europe, Q4 versus Q3 will be up in terms of absolute production levels. That's due to the production levels in European seasonality there. But down around 1% year-on-year, our view is it'll be down a little bit more than that there.
Also, the mix of the business within there will have a little bit more of an impact on us, with the Southern Europeans having more of a level down than that. So we're just a little bit more cautious than the others. If you look in North America, I think it's forecasted to be up 11%, be a little bit more cautious than that. I don't want to give you a figure. Asia, it's interesting. The last forecast I just seen is Asia would be 3% up, roughly year-on-year in the fourth quarter there. And I think that's going to be a tough target as well.
And just on Southern Europe, is SKF particularly exposed to Southern Europe?
No, no. I think by Southern Europe, I don't just mean the Southern European market. I mean, that manufacturing locations are there, which, of course, comes to the whole over Europe.