So ladies and gentlemen, a warm welcome to this press and analyst meeting covering the Q3 2019. We will be listening to a presentation by Volvo Group President and CEO, Martin Lundstedt followed by our CFO, Jan Uteberg. After the presentation, there will be a Q and A session. We will be taking questions both from the room and also from the teleconference. We would appreciate if you could limit questions to 2 at the time because we want more to have a chance to come through.
So a warm welcome, Martin. The floor is yours. Thank you, Claus.
So also from my side, most welcome to this quarter 3 reporting for 2019. Maybe before coming to the slides here and to frame it a little bit, I would like to start by saying that, of course, it is interesting times now. We see the anticipated correction coming in our main markets. We have been discussing that. We were already last year guiding for a little bit weaker market when it comes to Europe.
But we see that this correction will come. We are well prepared. We have been working with this obviously for a while now, both when it comes to Europe and North America. And what we see for this market is that they are coming down to more of the replacement needs basically. But I will come back to that later in the presentation.
Another part that is very important for us also is that we are maneuvering from a position of strength now at the Volvo Group. And we will continue, as you see also, a part of the news that we are presenting, invest in further innovation when it comes to business models provided by electromobility, automation and connectivity because here is an acceleration needed. And what I think is important to pronounce when people are talking about this is that this is giving immediate and big business opportunities for our customers when it comes to sustainability productivity and safety, and thereby, it will accelerate. So this is really based on business cases. So that is a starting point for us.
If we
look a little bit to the figures and highlights then, I mean, we have continued to grow, not a big growth this quarter, 2% if you are excluding currency. But we also have a strong level of profitability, a margin of 11% and an operating income of almost SEK11 1,000,000,000. Also when it comes to the operating cash flow, we are actually rather pleased with the situation. It is a seasonally weak quarter. As you know, now when we are flattening our production, when we are having the payables effect, I think we have been managing that.
But Jan will go through that in more detail later on here. In the volume development, for deliveries on in the Truck Group, we have a flat situation. We have increases then in North America given the strong order book that we have had and we are delivering out that. And we have also increases in South America, whereas we have a drop of approximately 10% for Europe and that is also following the plan that we are gradually adjusting now. When it comes to the machine deliveries, it is also a small drop as you can see, of 2%.
It is the Volvo brand that is dropping, mainly propulsed by stock operations and SDLG is increasingly 7%. On the service side, here we can also see a little bit that it's coming to a more of a sideway development now. A fleet activity when we look at the big truck markets are having a sideway development. A part of it is the fleet activity as such, but part of it is also that we know that our dealer partners, retailers and also customers that are sitting on spare part stocks are actually more cautious now. They know that we can deliver.
They would also like to adjust to not have and to carry too much stock. So there you have more of a onetime effect. But still, we see the potential in the service market. I mean, we have delivered a big fleet out now the last years. And maybe you can note also buses here positive.
One of the main explanations on that side is that we have been continuing to build out our network in North America for buses, mainly then for Prevot, our brand there. Another great milestone this quarter that has also been actually supported for the service growth is that we have been celebrating 1,000,000 connected units, buses, construction equipment and trucks. And why is this important? 1st and foremost that, I mean, when we have this type of population, of course, we can generate enormous amount of data and create patterns. And with our increased ability of utilizing AI and machine learning, we can utilize that to a big extent in our product development process.
But most importantly, obviously, is that we have been the leader in this when it comes to applying this for services and we will continue to be so. This is, as you know, the base for a better execution on all our service contracts that are gradually increasing also, not only the blue maintenance contracts, but also gold, including repair. It is the base for more granular and better execution on our financial services contracts, insurance. We are now also implementing what we call the truck monitoring services where we are actually anticipating and following uptime measures together with our customers. We have zone management, for example, also to apply safety measures.
But maybe the most important, this is the base for future automation and electromobility since electromobility also requires a lot of connected flows in order to make that optimal. So big milestone continuing to reinforce our leadership in this very important area. Connected to that is also the announcement today that we are creating a new separate business area for autonomous solutions, Volvo Autonomous Solutions. And as I said, the reason is that the potential value to capture through autonomous solutions level 4 when you actually are taking operators or drivers out of machines in the full or in different parts of the flow is enormous. We have already, as you know, demonstrated that in capital times now.
We have now signed the first commercial agreements. We would like to focus on this in a separate organization because we have seen how that is working well also for other parts of the organization when we are decentralizing and putting focus on it. And therefore, we have now decided to join the forces when it comes to development, when it comes to commercialization and when it comes to scaling up in Norway with a number of units that will be level 4 application and I will come back to another contract signed now. So full focus on this scaling up and, of course, in close cooperation with other business areas that are sitting with the customer contacts, that are sitting on the way to the market. But this is a business unit with full P and L responsibilities.
So we, as we go along, can showcase the big value creation opportunities that we see in autonomous solutions. On the truck side, one of the highlights I know that you look forward to is also obviously what do we say about the markets for next year. But before coming into that, some small corrections that we are doing now. Normally, it should not be too many corrections since we are in quarter 3 year. But for 2019, we are actually, for North America revising a little bit upwards.
Last quarter, we said $325,000,000 We see now more a level of $340,000 for the full year. And for 2020 for North America, we are forecasting our level of 240,000. So more coming back to the trend line, you can say, and the replacement need in North America. For Europe, we are not changing the forecast for 2019. And we are also, in that case, forecasting a correction down to the midpoint of the long term trend, you can say, over 300 on 275,000.
And I would like to say, I think that is pretty healthy actually. We've had strong markets now. And the more that will continue, the big, so to speak, the drop will be later on. So for me, I think that is good to see that we are forecasting that. Brazil, a small revision upwards for 2019 from 70,000 to 75,000 and we are keeping that level also for 2020.
If anything, I feel that there is an upward opportunity in Brazil actually. We have a strong momentum. I was coming home from Brazil actually in the mid of this week, And we feel that it's a good activity level. I will come back to that. China, we are revising a little bit upwards or a little bit.
It's always big figures as you know there from €1,150,000 to €1,270,000 for this year and then a level that is a little bit lower for next year. What we think is positive is that we see the gradual shift from medium duty into heavy duty also in China given the more sophisticated logistics solutions there. And obviously, I mean, that is important for Dongfeng. But when it comes to the shift for heavy duty, that is also a good trend for Volvo going forward and the more sophisticated segments there. Japan, flat guidance.
India, we are taking down a little bit now and we are keeping that level given the economic situation in India basically. But we are well prepared that and we have done a number of major corrections. On the order intake and deliveries, maybe spend some time then on North America here because it's always very dramatic when you see minus 81 percent. And I think the main message here is that, I mean, okay, we can say, okay, should it be 42,000 or 43,000 in orders and how much shall we talk about 35,000, 36,000 and then it's minus 20%. But minus 20% on what in reality, I think it's more important to think about where do we stand on the total market in North America, 240,000 where do we stand on the total market in Europe, 275,000.
For North America specific, just to drill a little bit on that. If we just assume for 1 minute that we went into 2017 with more or less a normal order book and a more or less normal inventory level. 2017, 2018, 2019, if you just combine up to year to date, we have now still a positive delta between orders and deliveries of 6000, 7000 units. Then you can say, okay, but how relevant is that given the fact that it's 2.5 years. It is relevant because we have gradually, as you know, been cleaning out orders that have not been relevant.
We have been reshaping the order book, etcetera. So I will say that during this very high peak periods, 2 peaks, and then the last cleaning out now of the order book, I think we still can say that we have this 6000, 7000 in Delta. Having said that, part of that is now parked in the inventory also because that is happening when you have had the big pressure of delivering. So what we see now is that the order book and the order board for us is on normal levels, 44% and in the beginning of Q1. But now it's time to really see that we get the balance.
Going in and adjusting the activity level down to the 240,000 anticipated level and continue to work with the right inventory level. So I think that is the message. The fleet season is here now. October has actually started good for us and it has started according to what we actually expect for North America. The same goes for Europe.
It looks like minus 20% for the quarter. I think it's more relevant to look at Volvo Trucks in this case because they are covering the full European market. There we are at minus €50,000,000 And that is, as you can see, also I think it's I'm rather proud about the lines here in Europe that we have a very good, so to speak, following between orders and deliveries. And we took the decision both for North America and Europe to adjust production already end of quarter 4 quarter 2 and we did it during quarter 3. So we are well balanced as we speak now.
As a matter of fact, we are actually doing some plus days now in Europe because we took it down, but I think that is a good sign that we are adjusting. For South America, orders very strong in quarter 2. So that's the reason why you see it's a little bit I mean, this is South America, but it was a very strong Q2 and maybe the most important explanation. Now we have Fana Tran in October. And what is Fana Tran?
That is the biggest truck exhibition in South America. And it's not only a truck exhibition, it's a sales fair. So I can just tell you that it has been some orders put in the drawer in order to have the opportunity to celebrate together at Fenner Sarnow in October. And I was there and selling some I should not say that I was selling, but I was at least part of the deals during Monday and part of Sunday and Monday. But the optimism activity level was good.
So I think we should see that you should be cool on South America here. And when it comes to Asia, you can say that it's continuing to roll on rather low levels, but a little bit weaker. Far East has been offset by some strong developments in Middle East here. On the market share, 1st and foremost on Volvo in North America, we have been losing a little bit of market share during the course of the year. We have discussed that before.
We have stabilized that situation now. We are not dropping. We have put priority on price realization. And during the course of the year, we have good products. We need to set the price level correctly, and that has been the main prioritization.
But now we see that there is time to gradually step by step with quality of the business to regain market share here. When it comes to Mack, we have actually been gaining market shares in all segments, but the mix makes it because they have a much lower market share on long haulage and therefore, it looks like it's pretty stable. But I think also with next year's decrease of the market, the mix will be favorable for Macka and their big presence in vocational trucks, for example. Europe, also there, started with a drop for Volvo Trucks, more or less the same story. We have stabilized that situation now.
Price is in focus for us. There have been a good market. We have had supply chain constraints, and we have made priority on the right type of deals here. But there is a room for improvement step by step. And Renault Trucks continue to be stable.
As you can see, the rest is positive. There we have established good execution of prices and now gradually we are taking better market shares. On the truck side, on product news, very quickly done, new introduction of fully electric trucks in North America. That is the VNR, the regional haulage truck. Very strong message, obviously, that we are also now moving in together with Mack when it comes to refuse executions.
And we will start limited, so to speak, production and to test the market in 2020. We are also introducing Volvo Dynamic Steering. That is a big invention, innovation that we've had for a number of years in Europe and also introducing that now in North America. Construction equipment. And when it comes to the market situation here, for very much the similar situation as for trucks when it comes to the major patterns, but maybe not as pronounced in some of the markets depending on the specific climates.
But North America, to start with, we are guiding for 2020 midpoint contraction of minus 5% from high levels. In Europe, minus 10%, midpoint provision from high levels as well. In South America, we are increasing a little bit the provisions of this year already, rather small volumes, but and keeping it flat next year. Think also here, we have an upward opportunity. China, maybe the most difficult, as always, to read here.
We are surprised about how well it's holding up. And even into September, we had a 5 plus 5%, 6% actually increase in GP sales, the heavy machinery. So we are guiding now that it's time for some sort of correction. We are saying 15%. That is very difficult always to say exactly what will be the stimulus activity levels, etcetera.
I think the main message for all of you to carry with you is that we are well prepared and we are on our toes here. And Asia then rather stable, a small contraction and that is mainly related then to India and Indonesia. Order intake wise, it looks more dramatic than related to what I said about the total market. But remember that we have big dealer groups here that need now to come into 2020 with the right stock levels. And what you see here is the orders and deliveries into our dealer groups.
So the main explanation of the deltas you see here, both on orders and deliveries in relation to our guidance, is that we have pushed for an inventory correction, which is in the long run is the right way to go. We also see that in North America, for example, we are doing some corrections on our rental fleet. That is also the correct way of going because you don't need the same type of but still good activity level. Also for Europe, we are doing the same thing, and that is what you see in the order intake. So we already started now in quarter end quarter 2, but mainly in quarter 3 to really also adjust our production and activity levels for construction equipment.
So we are doing the same thing that we are doing on the truck side. Then when it comes to innovations, we are now signing the first commercial contract with Harisko in Hufos. They are then transporting between steel mill and landfill and different type of recycling activities for units fully L4 automated. This is the next one next to Brondnoi down in Norway. And again, showing the strength of now creating Volvo Autonomous Solutions, full P and L responsibility, new business model, utilizing the modular car system of the group and benefiting from the enormous value potential both for customers and for ourselves.
Very proud of that. Buses, the general story is that we, if anything, see also a little bit of correction in the total demand. We are down 19 percent year to date. It has been a little bit difficult because India that is a big market and also U. K.
With Brexit uncertainty also pronounced that in quarter 3. Having said that, deliveries increased. We had a strong order book board when we went into 2019 and it is also like that. There are a little bit long lead times. Let's see now what will happen.
We have the Brussels Fair coming up during this week. We have a number of big attenders, and we cannot read it quarter by quarter. Same story, well prepared. And also our transformation program when it comes to buses is working accordingly. Breakthrough in Mexico, I'm happy to announce that because we have seen the importance of the bigger Latin American cities like Bogota, like Santiago, like Curitiba, and we are making more and more breakthroughs in Mexico for the higher type of buses Euro 6, for example.
Volvo Penta, very much affected by the pre buy, as you know, and also and Jan will come into that, that we continue to invest in innovation here. We have seen such good returns and rather short term returns when it comes to R and D investments in Penta. So we will continue to keep that on a high level. So we are making benefit of all the opportunities both in industrial and marine segments. And one example of that is the cooperation with Pajon when it comes to now fully electric powered sailboat when you're not sailing obviously, because that is one of the idea with sales.
But when you're not sailing, then it's electric. And finally then Financial Services. As you know, high quality business, good profitability levels. But we have said that a priority now given that quality in the business is also to increase the penetration. Penetration gives us loyalty, retention, good contact with the customers, and we have now gradually seen that we are doing so, but with, of course, keeping the quality in the business.
Also that we are more and more now financing and giving a full lease offering for also the electric vehicles. Here you see the Renault Master. The reason for that is obviously that they want to have this type of peace of mind and a strong start of our Korean operations also. We started in August. We are already now up to 38% penetration on trucks.
And we will in beginning of October, start also financing for VC there. So I think that is the business report you're on. So if you give the figures.
Thank you, Martin. I think we can summarize the 3rd quarter with the words happy for the past, prepared and humble for the future. The 3rd quarter was yet another quarter with improved operating income compared to the corresponding period a year before, 19 quarters in a row now with improved operating income compared to the corresponding quarter the year before. This time, the tailwind came from prices, offset then by higher R and D expenses and selling expenses and FX continued as it has done in the first and second quarter to impact positively also here in the Q3. Vehicle volume in this quarter was lower than in the Q3 last year.
That is a new phenomenon for us. We have not seen that for a while, but that is also a headwind we will have to get used to going forward here in the coming quarters. Moving over to net sales. In the 3rd quarter, affected then by the vacation period in Europe, net sales increased by 7% compared to last year and up then to SEK 99,000,000,000 if we take out currency, we are up 2% for the group. The currency effect is related to the appreciated dollar and also to the Japanese yen in this quarter.
Vehicle net sales increased by percent in local currencies, reflecting then decreased truck deliveries somewhat and machine deliveries as well, which was more than offset then by the higher bus deliveries and the improved pricing. The decrease of vehicles was related to Europe mainly then, almost compensated by another strong delivery quarter in South America. And service revenues, as Martin was into, more or less flat. If we move over to the group operating income, we have an increase here on adjusted operating income of SEK600,000,000 in the quarter up to SEK10.9 billion, 11% of margin. As I mentioned, the last quarter's volume has been the main contributor behind the improvement, not this time.
As I said, volume was a little lower than last year. Besides FX, we had the main contributors here now coming from a good price realization, both on vehicles and services and more or less across all truck divisions and business areas. A good sign of continuous improvement is in manufacturing and purchasing is when you actually have a lower cost per unit with the same production volume. And that was the case in this Q3 compared to the Q3 last year, a strong achievement, not at least taking into consideration that we are moving down production from higher levels, which means that cost and activities measures around that is not yet fully implemented and have the full effect in this quarter. And then on the negative side, we have region, brand and product mix in Construction Equipment.
I will come back to that later on. And this together then with the positive FX effect made the gross income increase by SEK 1,800,000,000. If we move over to the indirect expenses and start with R and D, we see that we have high activities both related to well known and new technologies. So the expenses, the cash R and D is up SEK750,000,000 €100,000,000 that is related to currency. And the delicate task is, of course, now to balance ambitions and resources with the legislative demands that we have on us.
And that will, of course, will be a challenge as we move into more of a sluggish demand situation going forward. Capitalization of R and D expenses and amortization are gradually coming into balance, but we still have a quarter with some positive effects. But last year, those effects were even bigger actually. So all in all, that meant that R and D costs in our P and L increased by some SEK 900,000,000 compared to last year. And for your guidance then for this full year, net capitalization will be slightly under SEK1 1,000,000,000 for the full year.
If we move over to selling expenses and increase there, we can say part of that is related to currency, part of that is related to higher activities and resources employed in earlier quarters. The focus is now to decrease ambition, activity level and thereby costs where selling expenses is, of course, one of the focus areas for us right now. The improvement of other was mainly related to some nonrecurring positive effects this year, whereas last year, we had some nonrecurring negative effects impacting us. All in all, currency SEK 1,300,000,000 impacting an operating income positively, mainly related to dollar and a general weak Swedish krona. And as regard the full year, we don't give guidance on the full FX effect, but we do it on the transaction effect and that is expected to be somewhat over SEK2 1,000,000,000 for the full year.
Martin mentioned cash flow. The 3rd quarter, so we just set the scene, is seasonally weak quarter, where working capital is negatively affected by the vacation period in Europe then. We are paying down our accounts payables due to the lower production level in Q3 coming in from the Q2. We have around 1 quarter of payment terms on accounts payables. In the Q3 this year, this effect was more pronounced than it normally is because we are reducing supply of new vehicles to the demand situation, but also to provide for a reduction of inventory.
Even though the cash flow was small in the quarter, SEK1.8 billion in industrial operation, we should also recognize that we were able to bring down the accounts payable to a new level by paying them down with SEK13 billion, which is quite good to be in the positive cash flow territory in a limited third quarter. Besides then the negative effect from payables, cash flow was impacted by the strong earnings, higher earnings in the industrial operation and also lower receivables where we had high deliveries towards the end of Q2 this year, which are now being brought in as payments and also we had a small reduction of inventory in the quarter. Capital expenditure in the 3rd quarter were some SEK3 1,000,000,000 affected by higher capital expenditure for property, plant and equipment and the high capitalization of R and D expenses. The trend of higher capital expenditures, which we have seen year on year, will prevail coming quarters as well. This meant that net cash were pretty stable between the quarters.
It's only affected by the limited cash flow then. And if we move over to our segments and start with trucks, we can say that despite then the lower deliveries with 1% more or less the positive momentum from early quarters for trucks continued here in the Q3 where currency adjusted net sales increased by 1% to some SEK64 1,000,000,000 mainly related then to the price realization both on vehicles and services. The lower deliveries were mainly related to Europe and to some extent Asia and once again a strong quarter in South America, I. E, Brazil and a smaller increase in North America, I. E, U.
S. Adjusted operating income increased from SEK 700,000,000 to SEK 7 500,000,000 giving an operating margin of 11.6% and main effects coming back to prices again as well as the positive effect of a lower per unit costs where the flexibility measures that we have performed have been well balanced with the demand situation and the material cost has been reduced in local currencies compared to last year then. We also have in the truck segment a gain of real estate of some SEK 200,000,000 and this was partly offset by higher R and D and selling expenses. And here, we have SEK 500,000,000 of positive currency effects. Martin mentioned the situation in Construction Equipment.
This, of course, means that we have also as regard since we are on deliveries minus 2%, we also have a deterioration of currency adjusted net sales of 4%, where we also have an effect of that the decrease is happening on more of heavy equipment, Volvo branded equipment, North America, Asia and where we have the increase then related to more of compact machines, SDLG in China. Currency adjusted service sales then up 2% and operating income deteriorated with some SEK 400,000,000 to close to SEK 2,200,000,000 And the deterioration was mainly related then to the negative product brand and regional mix as well as higher R and D and selling expenses somewhat and this was partly offset by the service volume that impacted positively. We should also remember that last year in this segment, we had a sale of real estate, a gain of real estate of SEK225,000,000 that impacted positively last year when we make the comparison. FX, SEK0.6 billion positively affecting the segment. Buses, here we can see that the financial performance for buses continued to improve.
Also in the Q3, deliveries of buses were up 400 units. We have the Bogota order that we are delivering off, but we also had, as you saw in Martin's slide, Mexico and Scandinavia impacting positively, which meant that we had a pretty big increase of vehicles net sales currency adjusted 33% and also a strong service sales quarter here with 9% up. Improvement of adjusted operating income of SEK 90,000,000 is, of course, related to the volume, partly offset then by the selling expenses being a little higher than last year. FX is quite limited in buses, €25,000,000 plus. And Penta then, Martin went through the pre buy effect.
We are still sort of handling. Decrease of deliveries then 12% mainly related to the engine or the industrial side and whereas we see diesel marine engines holding up better. Service revenues more or less flat and that is also a consequence that our customers are adjusting their inventory levels for tougher times. So compared to a strong Q3 last year where we had pre buy effects, adjusted operating income decreased from SEK230,000,000 to around CHF400,000,000 mainly related and to the lower deliveries, but also to the higher R and D expenses. Part of that is related to the fact that we are now starting to amortize on the Euro Stage 5 applications and part of that is the more forward looking things we are doing on electromobility and digitalization as well as somewhat higher selling expenses.
And here we have more of a positive FX effect close to SEK100 1,000,000. And last but not least, our Volvo Financial Services segment, where we have the high deliveries of vehicles then in South America, I. E, Brazil and U. S, continue to affect the new retail financing positively, increased to SEK19.3 billion in the 3rd quarter. Portfolio continued to perform well, but we have gradually seen a deterioration of payments, more of write offs, more of reschedulings and more of returns as well, still though at historical low levels.
The credit portfolio increased to SEK171 1,000,000,000 that is 12% up currency adjusted compared to the 3rd quarter end of Q3 last year. And the portfolio was also impacted then by high wholesale volumes in U. S. Adjusted operating income for Volvo Financial Services improved from €150,000,000 to €774,000,000 and that is a new quarterly record level for Volvo Financial Services, of course, impacted by the strong and growing portfolio that we have. Also FX had a positive effect here in the Q3 with SEK 50,000,000 on operating income and profitability measured and as return on equity sequentially increased slightly to 15%.
So then Martin, you want to summarize the quarter?
Yes. No, I think we almost started with that. But yes, to do that in 2 minutes then, I mean strong quarter, already started the adjustments for the anticipated corrections that we have in the main markets in a good way. Not only that we are planning for it, we are doing it as we speak and I think that is an important message both for construction equipment and for trucks. And that we are continuing to invest in the future also great opportunities when it comes to value creation for our customers and for ourselves.
Volvo Autonomous Solutions, I think, is big news that we are taking that seriously. So I think that is the quarter. And by that clause, let's open up for questions.
Thank you, Erik. Golrang from SEB. Two questions then. The first one is on the market share trend there, particularly Volvo, North America and Europe, which has been declining for some time. You said it had stabilized now.
You also said that you expected now also the right timing to start to regain a bit of share at least in North America. How will you be able I mean, we're in a very weak market, even it's still a declining market, very low order volumes. Is it possible to do that without giving up some of those price gains that you were so focused on getting in there for a good margin previously? Same question on Europe. And then on the second question would be on the new business area, Autonomous Solutions.
Could you say anything about what we should expect in terms of investment needs there, CapEx, R and D and put that in relation to your total budget up or down?
Thank you, Erik. 1st and foremost, on the market share thing, it's always easy to say, okay, we should regain market share, etcetera, and we are taking that very seriously. We will not do that to expense of quality in the business. We have been working hard to put, so to speak, price realization and quality at the right level. So we will not compromise on that.
Having said that, I think also we have to see that we have been in a situation with certain constraints also, not at least and in Europe. So don't expect any quick fix. We will take it step by step. We will make sure that we are protecting, so to speak, yes, the quality of the business that we have built up. I think the most important, we have stabilized.
We have seen that for of months and in the quarter now. And the main priority is to keep that balance, so to speak, and gradually regain. We should remember also that in Europe, even if we are talking about 15.3%, 15.4%, that is historically a rather okay level for Volvo. So it's no drama in this situation also given the supply chain constraints. When it comes to Volvo Autonomous Solutions, of course, now we are in the process of forming that, maybe to give some flavor of what we are thinking about.
When it comes to the development side, obviously, we will continue to deliver the redundant base vehicle or the redundant base machine in from the different business areas. And then it is primarily, so to speak, the autonomous level 4 stack for more advanced applications that will be developed into this business area. It is the control tower functionality so that you remotely can operate the different solutions and use cases. It is the commercialization in terms of application engineering, specific customer design. It is the rollout of scaling up and it is the operational part of it.
If so, customer chooses us to operate to get that act together, it will then obviously be in cooperation with the business areas that are sitting with the resources when it comes to field, people, etcetera. We will not double that to start with. So that is, so to speak, the setup. What we will do then is that we move the shank of investments in R and D that we are already doing and pointing at. And we really would like to see now the full P and L, so we can start really to judge and to get skin into the game that we need to scale up, etcetera.
So far, it is not a super big part of our R and D, but it is clearly possible to measure, if I put like that. And it when we are looking to the 2, 3 year coming period here, it will gradually increase because we will have this type of shift between the well known technologies partly and also the new technologies. So let us come back to that. But I think the visibility for us, for the whole organization and gradually for you will continue to increase it.
And Martin, maybe we should comment on the CapEx. I mean, we are ramping up from low levels, so that is not having a major effect going forward. When it will come material, we will come back with that. But right now, we
are But having said that also, the nature of these type of solutions is really to utilize the cost system in a smart way, get that together. And when it comes to hardware, it's very limited. This is the stack development. It is the control tower functionality. It is about applying the different type of capabilities we have from the different parts of the group and put it into place.
And we have always said that when Volvo is getting that together in certain segments, combining the strength that we have, we will be dangerous for real.
I'm saying hello, Handelsbanken. Two questions from me. Starting off on Europe, the production adjustments and run rate that you're currently running, is that the level that you want to be moving into next year the forecast you provided? On North America, you're guiding for 2.40 retail sales, then I would guess that the production should be at 2.20. And the question is then related to your run rate.
Are you needing to adjust more run rate in Q4 to handle that? And also, are digitals asking for incentives to move the inventory? Thanks.
If you start with Europe, our current judgment is that, I mean, we're on the right level. The reason why I say the current judgment is that you have to remember that Europe is not only Europe for Europe production, it's Europe for also other parts. But when we take Europe production for Europe, then we are on the right level. And even so that, as I said, had a pretty good start also October now. So we have actually been positively obliged to run some plastics also at this level, which I think is a good sign that we are all breathing the system.
But more importantly, not only production, we are all working hard also of adjusting all activity levels in the company to the current demand because in a company like us now, production is important, but it's important that the whole company is doing the job. When it comes to U. S, I think your analysis is right. That is partly also why we see what we see in order intake that we are pushing very much our dealers to say, guys, come in now with the right inventory levels, etcetera, because to have quality in the order board, the production levels, etcetera. We have done a number of steps already.
If that will be enough, let us see. We are discussing for further creations if necessary. And I can be 100% clear with you that we will not to any extent continue to produce if we don't feel that we have the right balance between inventory and market demand and production. We did it well in 2017 and 2016, 2017 there. And we have no reason to change the strategy in North America.
It's just to, but it's to execute on the same way of doing it.
All right. Let's see who's on the line.
Let's see if the lines are working.
The lines working? The
line of Claus Bergelind at Citi. Please go ahead. Your line is open.
Yes. Hi, Martin and Jan, it's Claus from Citi. So the first one is in North America. Last quarter, you outperformed the market for the first time in a while, and it seems like we were bucking the trend there finally. You had cleaned up the backlog early.
Now orders are falling more than the market again. Can we talk about pricing a little bit and mix between fleet and retail margin? Are you still cautious on taking on orders? I mean, I hear you on the retail comment, but just to get a feel for how you look at the new activity and between fleet and retail?
Yes. If we start with that, Claus. 1st and foremost, I think the fleet season is really right. We are in the middle of the fleet season as we speak now. I go to U.
S. Actually not next week, but the week after to meet with many of the bigger fleets in Atlanta on the big truck shoulder. We'll have a good feeling of that. The indication we can give so far is that the start of October has been according to our plans related to this both when it comes to retail and fleet activity. I think fleet activity is not only important for the fleet segment this time, but yes, to have the feeling of how they are anticipating their planning since they have a better normal view than the small customers.
So it will be interesting to follow this. I think, again, closer to what we said so far and that is also why I tried to explain during the presentation is that it is following our anticipated so to speak, and that is what we see right now. Do you want to add something there? Sorry, Claus.
No, my second one is on Construction Equipment and the mix. We have more compact and large, and STLG is growing faster than the Volvo brand. How should we think about the margin going forward? Will this mix negative continue? Or was it just 1 quarter?
And the reason for asking is that if production comes down with the volumes, then the money will fall from this 12% level. So is that the new base from here, maybe to 9%, 10%? And just to understand think about mix plus production going forward.
You'd like to start. Well, we have seen this trend with China and the compact machines for a while now. I mean now we have more of a decrease of heavy machines in Volvo brand, North America not at least. You were discussing how we our dealers are handling rental fleet and also their stock. So this becomes a little elevated in this quarter, but the underlying trend has been there for a while now.
And what we can say is also that we should also think about that Construction Equipment now is into a little bit of some transition quarters because they have been running on very high levels. As I said also in my presentation, when you look at order intake and deliveries for the time being, they're a little bit over pronounced in relation to what we are guiding for in total market. And that is good in a way because let's make sure that we are taking down inventory levels among our dealer groups that we are coming into 2020 in a good way. So we are well prepared because we feel that we have capacity in the system now and not dramatically overcapacity, but we have capacity in the system. Let's make sure that we are sitting with the right type of stock levels and inventory levels across the markets.
Thank you.
So we'll take another telephone caller.
Yes. We're over to the line of Sebastian Owen at Societe Generale. Please go ahead. Your line is open.
Yes. Good morning, gentlemen. One quick question from my side is also with regards to the U. S. Can you give some update here on the situation at the Mack Trucks about the strikes and the potential impact on your revenues and earnings this year?
And the second question would be also related to the Construction Equipment. You have drawn a pretty weak picture on the Chinese market in 2020. How do you see your capacities developing in this area? Thank you.
If we start then with the situation in U. S. And the ongoing strike in our Met facilities, The background of this is that we had, so to speak, a contract with United Auto Workers Union that expired here recently and we have had negotiations ongoing. For a while, we didn't reach an agreement and then the decision was from the unions to start this strike. I think it's very important to mention for us to start with that, of course, we have been working hard to reach an agreement.
We have also been working hard, the whole organization, as you know, to reach a reasonable and today a healthy profitability level. We have big investment needs in U. S. We have been struggling for a long period of time in U. S.
When it comes to the profitability. We are there now. We are not ready to compromise a sustainable, so to speak, agreement that can guarantee the right type of development for the company as well as for our colleagues because that goes obviously hand in hand. I can also say that we are apart from I mean, unique in that sense that we have 100 percent of our production for North America in U. S.
We are proud of that. But we also know that our competitors have the majority of their production in Mexico. So I mean, here it is important that we understand that a reasonable agreement is a must for us here. How long will it continue? We will not speculate in that.
We hope that we can reach an agreement as soon as possible. We will have continuous dialogues obviously about that. But again, super important for us is to have a sustainable level in order to be competitive in the future and also protect our employees. On the second part, when it comes to volume development for Construction Equipment in China, as I said, it has been surprising on the upside during this year. There is still a good activity level.
We had positive registrations in September for GP for the heavy equipment. So let's see. We are guiding now for a correction of 15% in the total market. And again, I think the main message here because that is always difficult to read depending on measures, etcetera, is that we have a high level of flexibility and we are prepared for different swings here. Yes, we have Lulu.
Thank you.
Thank you. Thank you.
All right. Let's take the room.
Christa Meiningold from DNB. To start with a question on R and D. Given that you're spending more on autonomous vehicles, electromobility, digitalization, you have new emission requirements, which was a big bump in Q3. At the same time, you talked about this downturn and how you handle that in 2020. So my question is basically what you would think about 2020 progression when it comes to R and D, cash and also amortization then?
No. First of all, a big part of our R and D portfolio is well known technologies and legislative demands. So that we will continue with. And of course, part of that is also electromobility to be able to solve that. So a big chunk of our R and D is, I won't say untouchable, but there we have to continue and of course do it in the most cost efficient way.
And then of course, it's more of how much can we put into things that are a little longer out in time without hurting ourselves. And that is a job that we are going through. It's, as I said, a delicate task in this situation. But of course, we will try to protect the future since we are coming from a platform of strength. But of course, we have to be very cautious here of what we do.
And as you have seen, the ramp up is there. And of course, even if we sort of start to decrease somewhat of our trend of increasing, then it will still be higher costs going forward because this is sort of a year over year you are referring to and that will mean that it is more.
But I think also what is important to remember here that is that we are a little bit stuck in our way of looking at the P and L. I will just take a little bit of a reflection on this. I mean, the beauty with business areas is that you can actually look through that they are not one size fits all because we need to have take Penta as a good example. We have been above what should be normal if we should have it the group average. You can see that.
And the reason for that is that we see that there's very good returns on our R and D investments. I think this is why it's important to start to separate and decentralize and clarify because the thing is what will be R and D and what will be selling and what will be other type of activities, what will be production in the future with these type of solutions. I think the main point is that we have said to you guys that we should be able to deliver 10% through cycle and we should also continue, so to speak, to have a smart allocation of capital. And I think one smart allocation of capital in this transformation shift is actually to invest in innovation and R and D, where a lot of these investments will have a relative short type of return as we have seen in Penta, as we see now when we are deploying actually the autonomous solution as one example. So I think, again, yes, we will see a little bit because we need to come through the peak here.
But in relation to the core industry, for example, where a lot of these investments are not giving any added value in reality, partly for society, which is great, I mean, when it comes to CO2, for example, but in reality for the mobility solution as such, our things are bringing real customer value to the customer, customers' customers the value potential is so big. So probably it would be a little bit left for us as well.
Then a question on cash flow to start with. Q4 is normally a seasonally strong quarter for you. You will have a destocking, but at the same time, you will lower production in North America, which tends to be negative for payables, if I don't remember wrong. So how should we see working capital effect in Q4? And coupled with that, the balance sheet going into 2020 will be extremely strong at the same time as you cut production.
So can that the lower production levels and layoffs affect the decision on the dividend going into 2020?
I can start with the cash flow. We there will be a strong cash flow quarter in the Q4 as well with the effects you are describing. So I won't comment more about the specific effects on accounts payable, etcetera. Maybe we should say something or not say something on dividend because it's not actually up to us. But of course, we will with the cash flow and the year with even better net financial position as it looks right now.
And then the decision about around that is, of course, that we have and look into the past, we have a benchmark of increasing our ordinary dividend that we have done. And in case of possibilities, we make extra dividends and let's see if we have that possibility without speculating about anything right now.
I think the message is also clear. I mean, important now, maneuver from a position of strength already now, make sure that we will continue to maneuver from a position of strength, I mean, given, I mean, the correction, etcetera. And at the same time, having said that, we have no intention to become a bank.
All
right. Tak, Bjornsson, Danske Bank. You talked a lot about the production cost, and you're quite good at explaining on the direct production cost and how flexible you are. Are there any measures? And if can you give some more details on the indirect cost development?
No. I think, Bjorn, it's a good point. I mean, as we always say, I mean, that are a little bit slower in following. But obviously, as I tried to say at least during the presentation that it is not only about, so to speak, the direct and the value chain related directly value chain related activities, but we are looking through, obviously, the activity level as a whole so we get the right balance. But in that context, I think it's important also to say that we are trying to be clear what we really would like to protect and pronounce, because in this type of situation, I think class companies can actually accelerate also the activities that will be important in midterm.
So we are absolutely we are doing that across the company.
And second question is on the payable impact in Q3. Was that mainly for the truck business a European impact? Or was that also in North America?
Mainly European impact since you have that normal situation in Europe of paying down payables.
So let's try the phone again.
Thank you. We are now over the line of Athira Prasdeep at Goldman Sachs. Please go ahead. Your line is now open.
Hi, thanks for taking my question. I had two questions. I'll just go 1 by 1. My first question is, are you seeing any signs of a price war in the Trucks business given you have strong pricing this quarter?
No.
No, thanks. And just following up on I'm actually going back to a question someone else asked on margins. If at the group level, given you're cutting your capacity and adjusting your inventory levels, do you think that margins will be temporarily affected by that? And if they are, what level do you think they can trough at? Like, are we looking at trough levels of 10%?
And is do you think they will normalize at this level? How do you see margins going forward on account of your capacity cuts?
Maybe I can start on the production side then. Of course, we have as we are saying, we have I'm quite proud of it. We have a lower product cost than we had Q3 last year. Of course, if you remember, we had some extra cost for bringing up the production as well at that time. But of course, we are using our flexibility and we are taking out costs.
But the further down we go, it will be more and more difficult because we have a certain fixed element that is pretty difficult to touch. So over the time, if this become worse, it will be more and more difficult of course.
But having said that, I think we are not are not obviously not guiding for trough levels, etcetera. But having said that, I think the story goes I mean, we have said that we should be a company that can be above 10% through cycle. And then obviously, when you're looking to different type of points in the cycle, we need to see a considerable improvement of what we have seen historically. But then it's up to you a little bit to do your work as well.
We
have anyone else on the phone?
Yes. We now go to the line of Olas Veraholm at ABG Sandal Collier. Please go ahead, sir. Your line is open.
Hi, thanks. It's Olof from ABG. Thanks for squeezing me in. I'll limit myself to 1 maybe since we're running out of time. The service business, can you talk a little bit about the growth path from here?
How long can this sort of caution to take on inventory at the customer side have a negative effect on growth? And do you expect to bounce back in 1 quarter or 2 quarters? How long should we how should we see this play out?
No, I think let's see a little bit here. You can take maybe a couple of quarters more. And then it's more related to how will the activity level continue to develop. Now we see a rather, as I said, sideways development on fleet. Normally, given also that we are increasing our penetration on contracts, etcetera, then the total sum should be somewhat positive.
But that I think is the offset now a little bit with inventory correction. So just to give you we talked a little bit about this yesterday just to remind everyone about the resilience of the service business in 'nine, 'ten or in 'nine rather when we had this big fall of what was it on 60%, 70% of hardware shipments, services dropped to 10%. So I mean and that was really, as you remember, a big hit. So the resilience is there. And I think also 1,000,000 connected units, we are doing a lot of focused activities.
Obviously, we will continue to have a very, very high focus the opportunities that the service business is offering or offering.
Perfect. Thank you. Thanks.
Okay. You're done. Let me ask. We're up
the stairs here,
and here we go.
Mats Lies, Kepler Cheuvreux. Just coming back to the European market share there, you mentioned 15.2% were real direct. But I guess some of your competitors have sort of renewed the offering now. And do you feel the need here to do the same thing? Or is it more could you give some more flavor there?
1st and foremost, I think that, of course, we have continuously renewed a number of things because what is renewal in our business is obviously not only related to the obvious things. I think we have introduced a number of very, very competitive features over the last couple of years here, not at least when it comes to axle configurations, the vocational offerings, volodymodynamics steering in more places, etcetera. So we have a strong offering basically. We're well spread across different type of segments. We see that we are underperforming in some, but more on specific markets, etcetera.
We have had high priority on the price realization. There is room for growing, but we will do that steady and with quality in the business.
Okay, great. And then just final one on guidance. There you estimate while 2020 is coming down in trucks. And should we expect that to be the trough year? Or I mean given your the historical pattern and so on, could you give some indications?
Let's see a little bit. I think that is early bird and we are not forecasting beyond that. What we see is that, I mean, it has been good years now for a couple of years, but it has not been a super big overswing. And I think that is good. So we don't expect the volatility to be as high as it was when we had this big over swing in the 6, 7, 8, etcetera.
So let's see. But I still think the main message is 275 strong. With 275 should we be able to have a good and healthy operation in Europe and that is what we are concentrating on right now.
All right then. This concludes this press and analyst meeting covering the Q3. See you all in 3 months. Thank you very much for showing
up. Thank
you.