Ladies and gentlemen, a warm welcome to this press and analyst meeting covering the third quarter 2019. We will be listening to a presentation by Volvo Group President and CEO Martin Lundstedt, followed by our CFO, Jan Ytterberg. After the presentation, there will be a Q&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 two at a time because we want more to have a chance to come through. A warm welcome. Martin, the floor is yours.
Thank you, Claes. Also from my side, most welcome to this quarter three reporting of 2019. Maybe before coming into 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, 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. What we see for this market is that they are coming down to more of the replacement needs basically. 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, 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 electro mobility, automation, and connectivity, because here is an acceleration needed. 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 and productivity and safety, and thereby it will accelerate. This is really based on business cases. That is a starting point for us. If we look a little bit to the figures and highlights then, we have continued to grow. Not a big growth this quarter, 2% if you are excluding currency.
We also have a strong level of profitability, a margin of 11% and an operating income of almost SEK 11 billion. 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. Jan will go through that in more detail later on here. In the volume development, for deliveries in the truck group, we have a flat situation. We have increases down in North America, given the strong order book that we have had. We are delivering out that. We have also increases in South America. Whereas we have a drop of approximately 10% for Europe. 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 propelled by stock corrections, and SDLG is increasing to 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. 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 parts 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. There you have more of a one-time effect.
Still, we see the potential in the service market. We have delivered a big fleet out now the last years, 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 Prevost, our brand there. Another great milestone this quarter that has also been actually supported then for the service growth is that we have been celebrating 1 million connected units, buses, construction equipment, and trucks. Why is this important? First and foremost, when we have this type of population, of course, we can generate an enormous amount of data and create patterns. With our increased ability of utilizing AI and machine learning, we can utilize that to big extent in our product development process.
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. 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.
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. 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 a couple of 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.
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 of autonomous solutions. We will already this year, as you know, start the operation that you can see up right here in Brønnøy, in Norway, with a number of units that will be a Level 4 application, and I will come back to another contract signed now. 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. This is a business unit with full P&L responsibilities. 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 market for next year. 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 three here. For 2019, we are actually for North America, revising a little bit upwards. Last quarter, we said 325. We see now more a level of 340,000 for the full year. For 2020, for North America, we are forecasting now a level of 240,000. 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, of 275,000. I would like to say, I think that is pretty healthy, actually. We have had strong markets now, and the more that will continue, the big, so to speak, the drop will be later on. For me, I think that is good to see that we are forecasting that. Brazil, a small revision upwards for 2019 from 70 to 75,000. 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 middle 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 years, 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 logistic solutions there. Obviously, 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. We are well prepared at that, and we have done a number of major corrections.
On the order intake and deliveries, maybe spend some time on North America here, because it's always very dramatic when you see -81%. I think the main message here is that we can say, should it be 42,000 or 43,000 in orders? How much shall we talk about 35,000, 36,000? It's -20%. -20% of 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 one 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 6,000-7,000 units. 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, et cetera. I will say that during these very high peak periods, two peaks, and then the last cleaning out now of the order book, I think we still can say that we have this 6,000-7,000 in delta.
Having said that, part of that is now parked in the inventory also, because that is happening when you've had the big pressure of delivering. What we see now is that the order book and the order board for us is on normal levels, quarter four and in the beginning of quarter one. 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. 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 -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 -50. That is, as you can see also, I'm rather proud about the lines here in Europe that we have a very good, so to speak, following between orders and deliveries. We took the decision, both for North America and Europe, to adjust production already end of quarter two, and we did it during quarter three. 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 two, that's the reason why you see it's a little bit, this is South America.
It was a very strong second quarter, maybe the most important explanation, now we have Fenatran in October. What is Fenatran? That is the biggest truck exhibition in South America. It's not only a truck exhibition, it's a sales fair. 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 Fenatran now in October. I was there and I should not say that I was selling, but I was at least part of the deals during Sunday and Monday. The optimism activity level was good. I think we should see that you should be cool on South America here.
When it comes to Asia, you can say that it's continuing to roll on rather low levels, but little bit weaker for it has been offset by some strong developments in Middle East here. On the market share, first and foremost, 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. 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. Now we see that there is time to gradually, step by step, with quality in 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 of long haulage, and therefore, it looks like it's pretty stable. I think also with next year's decrease of the market, the mix will be favorable for Mack 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. There is a room for improvement, step by step. Renault Trucks continue to be stable. As you can see, the rest is positive.
There we have established good executional prices, and now gradually we are taking back market shares. On the truck side, on product news, very quickly then, 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. 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 innovation that we've had for a number of years in Europe and also introducing that now in North America.
Construction equipment, 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. North America to start with, we are guiding for 2020 midpoint contraction of -5% from high levels. In Europe, -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, and keeping it flat next year. I think also here we have an upward opportunity. China may be the most difficult, as always, to read here. We are surprised about how well it's holding up, even into September, we had a +5%-6%, actually, increase in GP sales, the heavy machinery.
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, et cetera. 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. Asia, rather stable, a small contraction, and that is mainly related down to India and Indonesia. Order intake wise, it looks more dramatic than related to what I said about the total market. Remember that we have big dealer groups here that need now to come into 2020 with the right stock levels. What you see here is the orders and deliveries into our dealer groups.
The main explanation of the deltas we 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. Still, good activity level. For Europe, we are doing the same thing, and that is what you see in the order intake. We already started now in end quarter two, but mainly in quarter three, to really also adjust our production and activity levels for construction equipment. We are doing the same thing that we are doing on the truck side.
When it comes to innovations, we are now signing the first commercial contract with Harsco in Hofors. They are then transporting between steel mill and landfill and different type of recycling activities. 4 units, fully L4 automated. This is the next one next to Brønnøy then in Norway. Showing the strength of now creating Volvo Autonomous Solutions, full P&L responsibility, new business model, utilizing the modular core 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% 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 board when we went into 2019. 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 bigger tenders. You cannot read it quarter by quarter. Same story, well prepared. 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. We are making more and more breakthrough also in Mexico for the higher type of buses, Euro 6, for example. Volvo Penta, very much affected by the pre-buy, as you know. Also, Jan will come into that we continue to invest in innovation here.
We have seen such good returns and rather short-term returns when it comes to R&D investments in Penta, we will continue to keep that on a high level. We are making benefit of all the opportunities, both in industrial and marine segments. One example of that is the cooperation with the Fountaine Pajot when it comes now a fully electric-powered sailboat, when you're not sailing, obviously. Because that is one of the idea with sails. When you're not sailing, then it's electric. Finally then, financial services. As you know, high quality business, good profitability levels. We have said that priority now, given that quality in the business, is also to increase the penetration. Penetration gives us loyalty, retention, good contacts with the customers, and we have now gradually seen that we are doing so, with, of course, keeping the quality in the business.
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. A strong start of our Korean operations also. We started in August. We are already now up to 38% penetration on trucks. We will, in beginning October, start also financing for VCE there. I think that is the business report, Jan. If you give the figures.
Thank you, Martin. I think we can summarize the third quarter with the words happy for the past, prepared and humble for the future. The third 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&D expenses and selling expenses, and FX continued as it has done in first and second quarter to impact positively also here in the third quarter. Vehicle volume in this quarter was lower than in the third quarter 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 third quarter, affected then by the vacation period in Europe, net sales increased by 7% compared to last year, and up then to SEK 99 billion. If we take out currency, we are up 2% for the group. The currency effect is related to the appreciated U.S. dollar and also to the Japanese yen in this quarter. Vehicle net sales increased by 2% in local currencies, reflecting then a decreased truck delivery 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. 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 SEK 8.6 billion in the quarter, up to SEK 10.9 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. That was the case in this third quarter compared to the third quarter 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. On the negative side, we have region, brand, and product mix in Construction Equipment. I will come back to that later on. This together then with the positive FX effect, made the gross income increase by SEK 1.8 billion. If we move over to the indirect expenses and start with R&D, we see that we have high activities, both related to well-known and new technologies. The expenses, the cash R&D is up SEK 750 million, SEK 100 million that is related to currency.
The delicate task is, of course, now to balance ambitions and resources with the legislative demands that we have on us, that will, of course, be a challenge as we move into more of a sluggish demand situation going forward. Capitalization of R&D expenses and amortization are gradually coming into balance, we still have a quarter with some positive effects, but last year, those effects were even bigger, actually. All in all, that meant that R&D costs in our P&L increased by some SEK 900 million compared to last year. For your guidance for this full year, net capitalization will be slightly under SEK 1 billion 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 non-recurring positive effects this year, whereas last year we had some non-recurring negative effects impacting us. Currency, SEK 1.3 billion impact in an operating income positively, mainly related to U.S. dollar and a general weak Swedish krona. As regards the full year, we don't give guidance on the full FX effect, but only do it on the transaction effect, that is expected to be somewhat over SEK 2 billion for the full year. Martin mentioned cash flow. The third quarter, so we just set the scene, is seasonally a 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 second quarter. We have around one quarter of payment terms on accounts payables. In the third quarter this year, this effect was more pronounced than it normally is because we are reducing supply of new vehicles to the demand situation, also to provide for a reduction of inventory. Even though the cash flow was small in the quarter, SEK 1.8 billion in industrial operation, we should also recognize that we were able to bring down accounts payable to a new level by paying them down with SEK 13 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 a lower receivables, where we had high deliveries towards the end of second quarter this year, which have now been brought in as payments. We had a small reduction of inventory in the quarter. Capital expenditure in the third quarter were some SEK 3 billion, affected by higher capital expenditure for property, plant, and equipment, and the high capitalization of R&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.
If we move over to our segments and start with trucks. We can say that despite the lower deliveries with 1%, more or less, the positive momentum from early quarters for trucks continued here in the third quarter, where currency-adjusted net sales increased by 1% to some SEK 64 billion, mainly related 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 million to SEK 7.5 billion, giving an operating margin of 11.6%. Main effects coming back to prices again, as well as the positive effect of 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. We also have, in the truck segment, a gain of real estate of some SEK 200 million. This was partly offset by higher R&D and selling expenses. Here we have SEK 0.5 billion of positive currency effects. Martin mentioned the situation in construction equipment.
This, of course, means that we have also, since we are on deliveries -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 heavier equipment, Volvo-branded equipment, North America, Asia, and where we have the increase then related to more of compact machines, SDLG, and China. Currency-adjusted service sales then up 2%, operating income deteriorated with some SEK 400 million to close to SEK 2.2 billion. The deterioration was mainly related to the negative product brand and regional mix, as well as higher R&D and selling expenses somewhat. 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 SEK 225 million that impacted positively last year when we make the comparison. FX, SEK 0.6 billion positively affecting the segment. Buses, here we can see that the financial performance for buses continued to improve. Also in the third quarter, deliveries of buses were up 400 units. We have the Bogota order that we are delivering of, but we also have, as you saw in Martin Lundstedt'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 million 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, SEK 25 million plus. Penta, Martin went through the pre-buy effect. We are still handling. Decrease of deliveries then, 12%, mainly related to the engine or the industrial side, whereas we see diesel marine engines holding up better. Service revenues, more or less flat, that is also a consequence that our customers are adjusting their inventory levels for tougher times. Compared to a strong third quarter last year where we had pre-buy effects, adjusted operating income decreased some SEK 230 million to around SEK 400 million, mainly related to the lower deliveries, but also to the higher R&D expenses.
Part of that is related to the fact that we are now starting to amortize on the Euro Stage V applications, and part of that is the more forward-looking things we are doing on electro-mobility and digitalization, as well as somewhat higher selling expenses. Here we have more of a positive FX effect, close to SEK 100 million. Last but not least, our Volvo Financial Services segment, where we have the high deliveries of vehicles. In South America, i.e., Brazil and U.S., continue to affect new retail financing positively, increased to SEK 19.3 billion in the third quarter. Portfolio continued to perform well, but we have gradually seen a deterioration of payments, more of write-offs, more of schedulings, and more of returns as well. Still, though, at historical low levels. The credit portfolio increased to SEK 171 billion.
That is 12% up currency-adjusted compared to the third quarter, end of third quarter last year, and the portfolio was also impacted then by high wholesale volumes in U.S. Adjusted operating income for Volvo Financial Services improved some SEK 150 million to SEK 774 million. 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 third quarter with SEK 50 million on operating income, and profitability measured as return on equity sequentially increased slightly to 15%. Martin.
Yeah.
Summarize the quarter.
Yeah. No, I think we almost started with that, but just to do that in two minutes then. 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. 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 it's big news that we are taking that seriously. I think that is the quarter, and by that, Claes, let's open up for questions.
Let's open up the meeting for some questions. Please try to limit yourself to two questions.
Thank you, Erik. Göran from SEB. Two questions. The first one is on the market share trend there, on 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, the right timing to start to regain a bit of share, at least in North America. 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. 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&D, and put that in relation to your total budget up or down?
Thank you, Erik. First and foremost on the market share thing, it's always easy to say, okay, we should regain market share, et cetera. 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. 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 than in Europe. Don't expect any quick fix. We will take it step by step. We will make sure that we are protecting, so to speak, the quality of the business that we have built up. I think the most important, we have stabilized.
We have seen that for a couple of months and in the quarter now. 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. 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. 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 and 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, et cetera. We will not double that to start with. That is, so to speak, the setup.
What we will do then is that we move a chunk of investments in R&D that we are already doing and pointing at, and we really would like to see now the full P&L, so we can start really to judge and to get skin into the game that we need to scale up, et cetera. Far it is not a super big part of our R&D, but it is clearly possible to measure, if I put it like that. When we are looking to the two, three-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. Let us come back to that. I think the visibility for us, for the whole organization and gradually for you will continue to increase here.
Martin, maybe we should comment on the CapEx. We are ramping up from low levels, so that is not having a major effect going forward. When it will become material, we will come back with that. Right now we are.
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. 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. 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.
All right.
Hampus Engellau, Handelsbanken. Two questions from me. Starting off from Europe, the production adjustments and run rate that you currently are running, is that the level that you want to be moving into next year on the forecast you provided?
On North America, you're guiding for 240 retail sales, then I would guess that the production should be at 220. The question is then related to your run rate. Are you needing to adjust more run rate in fourth quarter to handle that? Also, are dealers asking for incentives to move the inventory? Thanks.
If you start with Europe, our current judgment is that we are 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. When we take Europe production for Europe, then we are on the right level. Even so that, as I said, had a pretty good start also October now. We have actually been positively obliged to run some plus flex also at this level, which I think is a good sign that we are breathing the system. More importantly, not only production, we are 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 you, as 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, et cetera," to have quality in the order board, the production levels, et cetera. We have done a number of steps already. If that will be enough, let us see. We are discussing for further corrections if necessary. 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, market demand, and production. We did it well in 2017, or 2016, 2017 there, and we have no reasons to change the strategy in North America. It's just 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.
Lines working? Yep.
For two questions. Mm-hmm.
Line of Klas Bergelind at Citi. Please go ahead, your line is open.
Yes. Hi, Martin and Jan, it's Klas from Citi. The first one is on North America. Last quarter, you outperformed the market for the first time in a while. 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, Martin? Are you still cautious on taking on orders? I hear you on the retail comment. Just to get a feel for how you look at the new activity and between fleet and retail.
Yeah. If we start with that, Klas, first and foremost, 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 show there. 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 just to have the feeling of how they are anticipating their planning, since they have a better, normally, view than the smaller customers. It will be interesting to follow this.
I think, again, Claes, to what we said so far, that is also what I tried to explain during the presentation, is that it is following our anticipated pattern, so to speak. That is what we see right now. Do you want to add something there?
I-
Sorry, Claes.
No, my second one is on construction equipment and the mix. We have more compact and large, and SDLG 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 one quarter? The reason for asking is that if production comes down with the volumes, then the margin will fall from this 12% level. Is that the new base from here, maybe to 9%-10% then? Just to understand how we think about mix plus production going forward.
Would you like to start?
Well, we have seen this trend with China and the compact machines for a while now. We have a more of a decrease of heavier machines in Volvo brand. North America, not at least, you were discussing how our dealers are handling rental fleet and also their stock. This becomes a little elevated in this quarter, but the underlying trend has been there for a while now.
What we can say is also that 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 the order intake and deliveries for the time being, they're a little bit overpronounced in relation to what we are guiding for in total market. That is good in a way, because let's make sure that we're taking down inventory levels among our dealer groups, that we're coming into 2020 in a good way, so we are well prepared. We feel that we have capacity in the system now, and not dramatically over capacity, 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.
Should we take another telephone caller?
Yes, sir. We're open to the line of Sébastien Wetter 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 Mack Trucks about the strikes and the potential impact on your revenues and earnings this year? 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 I start then with the situation in the U.S., and the ongoing strike in our Mack facilities. The background of this is that we had, so to speak, a contract with United Auto Workers that expired here recently. We have had negotiations ongoing for a while. We didn't reach an agreement. 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 we know, to reach a reasonable and today a healthy profitability level. We have big investment needs in the U.S. We have been struggling for a long period of time in the U.S. when it comes to the profitability. We are there now.
We are not ready to compromise a sustainable, so to speak, agreement, so 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 unique in that sense that we have 100% of our production for North America in U.S. We are proud of that. We also know that our competitors have the majority of their production in Mexico. 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.
Again, super important for us is to have a sustainable level in order to be competitive in the future and also to 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. Again, I think the main message here, because that is always difficult to read depending on measures, et cetera, is that we have a high level of flexibility, and we are prepared for different swings here.
Thank you.
Yeah, we have break even also. Thank you.
All right, let's take the room.
Christer Meineche from DNB. To start with the question, R&D. Given that you're spending more on autonomous vehicles, electromobility, digitalization, you have new emission requirements. We saw a big bump in Q3. At the same time, you talked about this downturn and how you handle that in 2020. My question is basically, what should we think about 2020 progression when it comes to R&D, cash, and also amortization then?
First of all, a big part of our R&D portfolio is well-known technologies and legislative demands. That we will continue with. Of course, part of that is also electro mobility, to be able to solve that. A big chunk of our R&D is, I won't say untouchable, but there we have to continue and of course, do it in the most cost-efficient way. Of course, it's more of how much can we put into things that are a little longer out in time without hurting ourselves. That is a job that we are going through. It's, as I said, a delicate task in this situation. Of course, we will try to protect the future since we are coming from a platform of strength. Of course, we have to be very cautious here of what we do.
As you have seen, the ramp-up is there. 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-on-year you are referring to, and that will mean that it is more. 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&L. I will just take a little bit of a reflection on this. The beauty with business areas is that you can actually look through, that they are not one size fits all because 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.
The reason for that is that we see that there's very good returns on our R&D investments. I think this is why it's important to start to separate and decentralize and clarify. The thing is, what will be R&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. We should also continue, so to speak, to have a smart allocation of capital.
I think one smart allocation of capital in this transformation shift is actually to invest in innovation and R&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. That's one example. I think, again, yes, we will see a little bit because we need to come through the peak here. 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. When it comes to CO2, for example.
In reality, for the mobility solution as such, our things are bringing real customer value to the customer's customers, and the value potential is so big, so probably it will be a little bit left for us as well.
A question on cash flow to start with. Q4 is normally a seasonally strong quarter for you. You will have de-stocking, but at the same time, you lower production in North America, which tends to be negative for payables, if I don't remember wrong. How should we see working capital effect in Q4? Coupled with that, the balance sheet going into 2020 will be extremely strong at the same time as you cut production. Can the lower production levels and layoffs affect the decision on the dividend going into 2020?
I can start with the cash flow. There will be a strong cash flow quarter in the fourth quarter as well with the effects you are describing. I won't comment more about the specific effects on accounts payable, et cetera. Maybe we should say something or not say something on dividend because it's not actually up to us. Of course we will, with the cash flow and the year, with an even better net financial position as it looks right now. The decision around that is, of course, that we have, and looking to the past, we have a benchmark of increasing our ordinary dividend that we have done. In case of possibilities, we make extra dividends. Let's see if we have that possibility without speculating about anything right now.
I think the message is also clear. Important now, maneuver from a position of strength already now. Make sure that we will continue to maneuver from a position of strength, given the correction, et cetera. At the same time, having said that, we have no intention to become a bank.
All right. Here we go.
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 can you give some more details on the indirect cost development?
I think it'd be honest, good point. As we always say, that are a little bit slower in following, obviously, as I tried to say at least during the presentation, that it is not only about, so to speak, the direct and the directly value chain related activities, we are looking through, obviously, the activity level as a whole so we get the right balance. 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 close companies can actually accelerate also the activities that will be important in mid-term. Absolutely, we are doing that across the company.
Thank you. The 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.
Let's try the phone again.
Thank you. We are now over the line of Daniela Costa 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 one by one. 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 signs. 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? If they are, what level do you think they can trough at? Are we looking at trough levels of 10%? 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. Of course, as we are saying, 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. Of course, we are using our flexibility and we are taking out costs. 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. Over the time, if this become worse, it will be more and more difficult, of course.
Having said that, I think we are obviously not guiding for trough levels, et cetera. Having said that, I think the story goes like, we have said that we should be a company that can be above 10% through cycle. Obviously, when you're looking to different type of points in the cycle, we need to see considerably improvement over what we have seen historically. Then it's up to you little bit to do your work as well.
Thanks. Have anyone else on the phone?
Yes. We now go to the line of Olof Cederholm at ABG Sundal 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 one 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? Do you expect to bounce back in one quarter or two quarters? How long should we wait? How should we see this play out? Thanks.
I think, let's see a little bit here. It 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 rather, as I said, sideway development on fleet. Normally given also that we are increasing our penetration on contracts, et cetera, then the total sum should be somewhat positive. That I think is the offset now a little bit with inventory correction. Just to give you, we talked a little bit about this yesterday, just to remind everyone about the resilience of the service business. In 2009, 2010, there were in 2009 rather when we had this big fall, we of what was it, Johan? 60%-70% of hardware shipments, services dropped with 10%. That was a really, as you remember, a big hit. The resilience is there.
I think also 1 million connected units, we are doing a lot of focused activities. Obviously, we will continue to have a very, very high focus on the opportunities that the service business is offering.
Perfect. Thank you.
Thanks. Hello. Okay, you're done.
Mats
work the stairs here. Here we go.
Hi. Mats Liss, Kepler Cheuvreux. Just coming back to the European market share there you mentioned 15.2% for your trucks, but I guess some of your competitors have sort of renewed their offering now. Do you feel the need here to do the same thing? Could you give some more flavor there?
First 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 competitive features over the last couple of years here, not at least when it comes to axle configurations, the vocational offerings, Volvo Dynamic Steering in more places, et cetera. 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, et cetera. 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. Then just a final one on guidance there, you estimate, while 2020 is coming down in trucks, and should we expect that to be the trough year? Given your historical pattern and so on, could you give some indications?
Let's see a little bit. I think that is a bit early. We are not forecasting beyond that. What we see is that it has been good years now for a couple of years, but it has not been a super big overswing. I think that is good, so we don't expect the volatility to be as high as it was when we had this big overswing in 2006, 2007, 2008, et cetera. Let's see. 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. This concludes this press and analyst meeting covering the third quarter. See you all in three months. Thank you very much for showing up.
Thank you.
Thank you.