Welcome to the Volvo Group Q3 2018 results call. To ask a question during the Q&A, press zero one. Now please say your name and company after the tone and then press the hash key.
Jenny Loose from S&P Global.
Welcome. Before coming into the results and our views of the market for quarter three and going forward, I also would like to give you my view on the latest update on the press release regarding degradation of the emission control components that we were releasing this Tuesday. I will need to take the background of this also. As you know, to meet emission limits in different forms, we have different systems for that. In this particular case, we are talking about the engine aftertreatment system that is physically placed after the engine. In this engine aftertreatment system, you also have the selective catalytic reduction system, the SCR unit, that is actually then taking nitrogen oxides into nitrogen and water respectively by also adding urea or AdBlue, as it is called in our business.
One of the components in the SCR catalyst have shown in some cases that the degradation, and degradation in this matter is like if it was a mechanical component, a premature wear and tear over the life cycle. In some applications and segments and possibly geographies, we see that it might occur that the degradation is quicker than anticipated. This component is designed to withstand the whole life cycle of the vehicles and equipment. In specific cases, we see an increased risk that it will not do so. Therefore, we have taken measures obviously. What has happened, it's also important to say that we have detected this in our internal monitoring processes that is ongoing all the time when it comes to the fleet in the field.
When we have, so to speak, come to the conclusion that we will have a risk of certain applications, we need to have some sort of action. We have obviously also had a proactive contact with authorities and eventually also when we have looked through this matter, a disclosure that we did on this Tuesday with a press release. I think it's important to say that, again, the reason now when we are doing this very thorough analysis is that it is, as I said, a wear and tear matter, and we need to understand the pattern. Where it is happening, and why, and how can we actually then make sure that we are doing these preventive actions in a good way together with our customers. We have fully identified the problem.
We have ring-fenced the problem, and we are now, as we speak, implementing and will continue to implement solutions. It goes without saying, obviously, but I will say it anyhow, that this is work through now with the highest focus, with the best experts we have, together with concerned authorities. It is important now when we have identified the solution, how do we actually look at the full scope of what is really the affected population in this matter? That we are doing, again, as I said, in close cooperation with authorities. All vehicles and equipment are and have been, so to speak, on the right levels at delivery and fulfilling the certificates and conformity of production. Therefore production is not affected. Customer performance also when it comes to uptime, availability, and performance features is also working as planned.
In the case, obviously, that a degradation has occurred in a specific unit, Volvo is together with customers, but Volvo is taking, of course, the full responsibility. I understand that all of you have been questions about this, want to know more about the details, et cetera. We have said it's very important now that we take this matter, of course, extremely seriously, and that we are working with this with high attention, high focus, but also with quality, so we can ring-fence and come back to relevant stakeholders with the right type of figures. Again, on our own initiatives, a degrading matter, a problem that we have identified and solutions that are ongoing as we speak. That is the update on this press release from my side.
By that, actually, we are moving into the next stage, and that is the quarter three reporting for Volvo. As you have already seen, it has been a strong and solid quarter for the group. Sales continues to increase, and we are reaching a record level for quarter three of SEK 92 billion. That is an increase of approximately 13% when it comes to sales, excluding FX. An operating margin, as you have seen, 11.1%, both for the group but also for trucks. Trucks, it's good to see that we are getting the leverage that we have been talking about for a while here, and a very good job done by our truck team business areas. We also see improvements in the other non-truck business areas, so a strong quarter.
When it comes to volume development, also in this case, I should say that we are rather satisfied with the volume development, +14% for trucks. It was actually almost 14% for North America. Even if the supply chains are stretched, and we are reiterating that, one should understand that while we are now increasing, obviously, new bottlenecks will be detected while we are removing other bottlenecks. That is the nature of a business. If you think about the global industrial machine, increasing 15%, and certain regions 40%, I think the organization has done a good job here, and we are concentrating efforts to continue to drive this together with suppliers, but also in our internal processes. Machine leasing is also showing a good trend, 17% up, where SDLG is standing for 35% on the SDLG branded machine and 5% up for Volvo.
The service development is also positive for us. We have +7% excluding currency, that is a good growth rate. Of course, mainly driven by high activity level in the different regions, but also a strong focus on services in the organization. The contact penetration of repair and maintenance contracts, for example, is continuing to increase, and that is extremely important for us, as you know, also when it comes to our resilience through the cycle. Even more important, that is showing us that we have good and close contact with our customers. Also, new penetrations when it comes to selected segments are given results here. For example, Volvo Trucks have been putting a lot of focus in Europe on the construction segment. That is also promising when it comes to the contract length of the first owner of the leasing construction.
As you can see, all different business areas are showing progress, in particular, we are pleased to see the progress in buses as well. When it comes to trucks, I will keep it short here. The main sentence to remember on this slide is the first one, good demand in key regions, the rest I will cover in the coming slides here. When it comes to innovation, a very interesting quarter, obviously. We were pushing through this world premiere of what we call Vera. She was shown first time actually in Berlin at our Global Innovation Summit with big interest, and some of you were there actually. We were very proud to show that this is a fully autonomous, fully electrical, and fully connected unit for certain transport applications, primarily for fixed goods flows of pretty high volume.
The starting point here will be that it could be operated fully autonomous, but also for certain specific tasks through a control tower application as well. We are now developing the solution as such together with customers and other partners, some of the features here, that is interesting, by the way. We are talking today about production flows, because this is a typical tool for a production flow. Speed is not the most important when it comes to average speed. We are talking about the starting point is 40 kilometers per hour. That is maybe not impressive, but the impressive thing is that it can control an even flow as you are talking about, for example, in a production environment. The limitation is not the 40 kilometers, but we will have an even flow when it comes to that.
22 tons, 200 kilowatt-hour batteries, range of 100 km to start with, and a full infrastructure and system solution thinking. Very promising, high level of interest. Other thing that has happened this quarter, obviously, is the IAA exhibition in Hanover, one of the lead truck shows in the world, every second year, where we actually also showcased a number of important events for the Volvo Group. We delivered 1 million FH, a milestone for us, celebrating 25 years since inception. A big success for Volvo Trucks, you can see on the upper left side there. We introduced Volvo Connect. That is our new platform of connectivity, where the customers actually can take their view of connectivity and group their, so to speak, features, applications, the Volvo applications, but also applications from other partners.
That has been well received also when it comes to functionality and easy to use and easy to connect. Vera again, you see there. That was one of the highlights, obviously. We were introducing the new coach series for Volvo Buses in Europe, the 9700 and 9900, and the 9900 got the Sustainability Award of the Year. In the middle, on the download, a full range of battery electric vehicles in distribution and waste collection, both for Renault and for Volvo Trucks, and also well represented press conferences about our new team. We are coming in then to our views of them, as you know, we are today revealing our first views of 2019 and forecasts.
As always, we say that it's early days, but we are of course taking it from the angle we see now and also some of the macroeconomic indicators we're getting in from around the world here. We start with Europe. As you can see, a little bit of uptick already in 2018, meaning that the strong demand continues. As the forecast for next year, we are guiding around 300,000. That is -5%, is it? Early days to say, but what we forecast is a stable demand on high levels to continue. I've been discussing this before also. It is a good activity level when we read our customers, when we talk to them, and also the structural things happening in the market, for example, with e-commerce will also actually support that we will continue to have a good level of activity.
North America continue also to be very strong. 310,000 is a continuous uptick then, and if anything, there is a pressure that it could even be stronger, but this is what we see for the time being here. As you know also, part of this has been hampered by the supply chain also in North America, which is also given a situation where the used truck situation is good now in United States because capacity is needed, basically. Also there, 310,000. We are guiding up slightly in Brazil. Of course now we are waiting for the second round in elections in Brazil. The general, so to speak, sentiment in Brazil is that it will continue. As you can see also on this graph, there is certain replacement need in Latin America and in particular in Brazil.
If anything, this is also a forecast that can have strong support upwards. Japan is flat. In China, we are taking up 2018 with 50,000 units to 1.3 million. Next year we forecast somehow a decline of approximately 150,000 units. It's a bit related to macro and tariffs and the general economy. Also in our industry, after a number of very strong years, new legislations, the pre-buys, the transition into tractor segments, the construction has been keeping up, et cetera. It is reasonable to think that you will have a stabilization and somewhat a decline here. Still very good and solid levels, obviously. In India, we are continuing to see an uptick of approximately 25,000 units up to 425 for medium and heavy duty combined.
When it comes to orders and deliveries for trucks, you can see a solid quarter, continue to be very strong when it comes to the order intake. If I start with 28% up. If I start with Europe, positive to see that even that we have high comparison figures now, quarter-on-quarter. We are moving north at 5% with orders and 4% with deliveries. Also North America, extremely strong. I could assume without knowing what questions you have in your back pocket, what is the quality of the order book? Maybe I should just take one minute on that. You need to be sober when you are judging the order book, obviously. What we are doing is that we take it pretty firm for the coming 2.5 quarters, that we know that we have the right quality.
The rest of the order book, we are actually revisiting as we are rolling it forward together with customers and dealers. That I think has been an improvement in our way of working. We are actually revisiting and see what are the orders that are working and what are placeholders, et cetera. I think we have a good system on that. As you can see also, the gap between orders and deliveries are still big here. 40% is still a good figure, I feel, for our uptick in deliveries on North America. Also very strong in South America, both for orders and deliveries from low levels. As I said, we see that the activity level is good here, both when it comes to the general cargo, but also in specific sectors such as agriculture.
Asia, orders down. That is almost entirely related to Middle East and the two countries there, and that is Iran and Turkey, basically, with the turmoil that we are seeing. In Africa and Oceania, it continues on a good level here. Market shares. Europe, relatively stable. We are sliding little bit in Volvo. Depends a little bit on the market mix and where you have market share. We have also been pushing prices a bit. We have been thinking that it has been necessary now, given the good market situation, the question we've had on deliveries, we said that we need to find the right balance here. Still good levels for Volvo, if you think also about the historical perspective. I think they are managing in a very good way here. Also, the stabilization and some uptick for Renault continues.
As we have said, quality in the business has defined focus, and stabilized the market share. The organization has done a very good job here. This is heavy duty, and we see also good progress in medium and light duty for Renault. North America, good progress for Volvo, keeping up with the pace in the market and even taking market shares. Good reception of the new VNL. Strong order books. Well-received product when it comes to performance. 10.5%, obviously, there is more to go there, but we are working hard on the supply chain. Mack, losing a little bit, not due to the introduction of the new Anthem. That is super well received. We have order books that is covering a very big volume next year.
More related to the changeover, obviously, after the changeover, to really get the machine and the full supply chain, including our internal processes going. The organization is focusing a lot on that, and Martin Weissburg and the team have all hands on deck to continue because the demand is there, and there is a huge excitement about the Mack Anthem. Good progress in Brazil. Also good in North Africa and Australia, where we are keeping very strong positions now that we have built up during the last years. In Japan, a little bit the same situation for Volvo Trucks. In Europe, we are balancing, so to speak, market shares also with the performance in UD where we see good progress actually, and that is the most important focus that we have had there.
Construction equipment, good market momentum, Europe and North America. We'll come back to that. China is something, the growth rate slowing down. Natural, obviously, I've already been into the reasons, and very similar to trucks. We see it more also coming now. It started in wheel loaders, but we see it also coming in excavators. Order intake overall good, 22% up, and deliveries 17% up. We also have a fully electric compact excavator will be used in city centers, urban areas where, of course, both from an emission level standpoint, but also a noise emission standpoint, very interesting. On the next slide here, maybe you saw a little bit on that movie, the electric site concept that we are starting now to test together with Sandvikan. We are doing that in Draggängarna. That is one of the bigger quarry sites in Sweden.
Actually, it's well-situated, I should say, at Hisingen. From, so to speak, a technical and system perspective, we can work very closely together. This will be conducted now during a couple of months really to test the full system, both with loaders. You can see these fully autonomous load carriers together with hybrid wheel loaders and also with fully electric big excavators. Our aim here is to considerably reduce the CO2 up to 95% if we are successful, and total operating cost with in total 20%. Very exciting project to look into here and to follow during this fall. When it comes to the market situation, what you can say, Europe very quickly, we are guiding a little bit upwards for 2018. As you can see, we are forecasting a little bit flat for trucks, a stable situation on high levels for 2019.
North America, also there, we are guiding up for 2018, five percentage points, so between 15% and 25% growth. Also we are forecasting growth for next year. If anything on that growth rate, we foresee actually that the growth will primarily take place on the heavy equipment in North America and maybe not so much in compact we have seen historically or this year, I should say. China, again, upgrading total forecast for this year with five percentage points. We, for next year, are talking about maybe -5%, a little bit coming down, but still on good and solid levels. If anything, we think that wheel loaders will be more stable and maybe a little bit bigger book on excavators, but early days to really see that.
Otherwise, I think Asia following the same pattern as China, you can say, but also good levels, somewhat of a small increase, but still on solid levels. Let's see. There we have it. Orders. We have been into it, pretty straightforward. Strong order intake, 22%, driven from Europe, 53%. I should say part of that has been driven by a pre-buy in compact equipment up front legislation. Still, if you take the GPE or the general purpose equipment, the heavy side, even in that sector, we have a growth of 22% in Europe. Sweden, if you take away, so to speak, the pre-buy is only then strong demand. North America, the same, very strong. It has been driven by that compact, but we see also the heavy side coming. Generally speaking, it continues on good level with the rest of the world as well.
Delivery is keeping up, there we have had less problems or less challenges than we have had on the truck side. Now the truck side is keeping up here. Buses, good order intake after a pretty slow order intake in 2017. That was a slow year when it comes to tendering activities, not at least in the Nordic market, but also in some of the big countries in Asia. Now that is coming back, mainly driven by U.K., the Nordics, and as a matter of fact, India. The deliveries decreased, but Johan will come back to that we see that buses are doing a great job in compensating that through other factors. I was into also that we have introduced now two important coaches for the European markets, 9900, 9700, and we got this award. Volvo Penta, also solid, 8% increase order intake.
If you take away the pre-buy, there you have high comparison figures already from last year, it is only 1%. The pre-buy phase is pretty big here. Still a very high level of order intake also given good activity level already last year. Deliveries also continue to increase, new features for all of us that are interested in having a nice vacation. Obviously, with the new positioning systems, the active ride control, decreasing, so to speak, the rolling feeling when you're out, also active corrosion protection when you're using chemical actually to take down certain type of corrosions. Financial services also finally, good development continue to be good. The penetration rates are stable around the globe, financing on new businesses are reaching record levels also with a very solid performance.
We have also been working actively to show that we are together with the customers when needed, as I also stated in this press conference. Also here with the Hurricane Florence, we are working together with our customers that are unfortunately affected by that in a good way. We have also introduced a number of even more integrated offers with our different business areas. Also here, very good progress. Now with that, actually, I will give the word to Jan Gurander for the financial figures. Please, Jan.
Thanks, Martin. When we talk about the financials and the figures, a pretty straightforward quarter. I think also worth to remember, the third quarter is usually season-wise actually the weakest quarter that we have. I think pretty proud to be here and say that this is actually the best third quarter that we have ever had in the group. Looking into the sales is up with 21% for the quarter. If you exclude the currency effect, which is pretty substantial, as you can see, almost SEK 6 billion. We have an underlying growth of 13%. As you can see here, it covers really in all regions with the strong developments that we have seen that Martin showed before. The operating income goes, and here we have the adjusted operating income, is going from almost SEK 7 billion the year before.
Last year, we had a capital gain of SEK 400 million that's now excluded in these figures, up to SEK 10.2 billion this year, 11.1% operating income margin for the group. We can see here that, once again, it's always very fun just to stand here and say that it's actually all business areas in the group are contributing to the improved results. When we see that this broad-based continuous improvement that we have it in the whole group, I think we can be very satisfied. Obviously here, I think we have gained quite a lot in the group by the fantastic performance that we're seeing in Volvo Construction Equipment. I think this quarter now, I think you can really see here that Trucks really has taken off in this quarter compared maybe a little bit to previous quarter, have a good leverage in the truck operations in Q3.
One word about currency, that's something that you always want to know a little bit about when it comes to the future. When we look into the fourth quarter, when it comes to the transaction exposures, taking away the effects from revaluations of the balance sheet, we foresee a similar size of the positive effect that we are having this quarter, approximately SEK half a billion. We don't do any forecast for next year yet when it comes to the currency effects. Doing the same thing here, and see what factors that affected the result. It is obviously about volumes and of course a better capacity utilization in our factories. Anyway, I think it has been good development over the year. We started to see it in the first quarter when it comes to how we work with price and price management.
Of course, given the good demand that we have, the bottlenecks that we have in our production, it is of course important to work with that side of the equation. We saw it gradually coming in in the first quarter, more pronounced we saw in the second quarter, it continues in the third quarter as well. Good and solid both from vehicles, but also in our service operations. Material cost is, of course, same thing as we have had before. We are struggling with raw material prices. Effects from tariffs, we talked about that before, especially regarding North America with the tariffs on steel and aluminum. We, at the same time, due to good work that's been done within our purchasing organization, we've managed to offset that more or less one to one.
As a matter of fact, we have a small positive effect if we net the work that we do on the price side with the raw materials. That we see going forward as well. The mission has been to offset the raw material with the work we do on the price side. We see here that service sales is, of course, improving our results quite a bit. It is an important component, both in good times, but of course, especially when you're coming down to us, because that's a very good cushion to have then for the results. We see that also we are helped. We are in a situation right now where we capitalize more than we amortize in our P&L.
If we here also look for the forecast for the current quarter, it is approximately as an effect of SEK 0.5 billion for Q4 that we foresee higher capitalization than amortization. The things that are affecting us on the negative side, selling expenses. We are growing as a company. We have a higher top line, and of course, there are things, factors that increase our selling expenses. We are very careful when we add on these costs that we have here, try to keep them as flexible as possible, so if and when the downturn comes that we have the flexibility to take care of that. Extremely important, hard work in that in the organization for the time being.
As we have said before, when it comes to the cash underlying on the expenses, they are gradually coming up here, this is according to plans that we have [in 12 years]. They will also, in a cautious way, continue a little bit upwards as well. Cash flow, third quarter is, seasonal-wise, the weakest quarter we have in terms of cash flow. From that point of view, maybe not so much to say about. It's more or less on the same level as we have seen in the last couple of years actually. I think it is, anyway, worth. This is an area that we are not 100% satisfied with. This is, I would say, especially on the inventory situation. Now that we come into the fourth quarter, it's a high focus in the organization to basically secure that we get down the inventory.
We will trust the good markets that we have out there, high demand and so on. We need to continue to keep high focus on that. Part of the problem here is, of course, when you have the disturbances that we still have, I will come back to that on the truck operations, the disturbances we have on the supply chain, it means that you have a little bit higher inventory. You don't have the perfect, efficient organization. Components are standing a little bit longer than what they should. You can also, from time to time, miss delivery slots to customers and so on. It is not efficient. It's definitely more to do that on the inventory side. The payable side is kind of a seasonal effect that we have every time in the third quarter before we start to ramp up the production.
Truck sales, delivered trucks, as we said, strong growth, almost 40% in North America. Europe, 4%, that's a total 14%. Total sales, when we take away the currency effect, is 15%. Service is 8%. I've always said if you are north from 5% in services, if it's not to go up to 10 in this type of business, it's really good growth rates that we have. In total, if we take away the currency, 23% up in sales. Here, trucks, as I said before, we are so happy to see now that we, 11.1% in the third quarter, good leverage as well, approximately 22%, which I think it should be actually on pretty normal circumstances. It is a good leverage for the truck operations. SEK 4.2 billion up to SEK 6.8 billion, and on the margin, going from 8.5% to 11.1%.
As you can see here, it's basically the same explanation factors when it comes to the goods and positives and the minuses on the result explanation. Trucks is so big, of course, in the group, that's why it influences the whole group as well. It's worth to mention here, we do still have. We are not perfectly fit on our end. We still have constraints on the supply side. We are not 100% efficient. The reason why we don't mention it here is that that was the situation in the third quarter last year as well. You can say the increased cost level that we have, still have in the third quarter this year, is more or less on the same level as what we had Q3 last year. You could say the elevated cost level that we have is not gone yet.
The machine is not 100% ticking as it should do. On construction equipment, 17% up in delivered machines, 16% up in currency adjusted in terms of sales. We have here also services, 6%, healthy levels. We see also a pretty good product mix as well. Large and medium machines up 19%, smaller growth rate on compact. SDLG is usually actually a negative thing on the product mix, we have pretty healthy profitability right now in China. It doesn't affect us so much on the mix side. Here, going from SEK 2 billion up to almost SEK 2.6 billion, an increase on the operating margin, almost up to 14%. Same story here as we have seen before. Managed to take care of the growth. We see that, of course, service sales and the capacity utilization is helping us on the profitability. Leverage of approximately 16%.
We maintain also the cost discipline in Volvo Construction Equipment, which I think is very good, and it's, of course, always important. When we have taken all the measures and right-sizing, and what we see, to be able to take care of the good increases we see on volumes by maintaining cost is important to us. Very good. There may be a question on why don't we see the effect of the result on property in Korea in the third quarter. year-over-year is not a difference because we sold the dealer in the U.K. last year in the third quarter, it's more or less exactly the same effect. We have SEK 200 million in this quarter. If you compare the results, it's not an explanation factor quarter-over-quarter. Volvo Buses coming down in delivered volumes, as Martin said before.
Of course, also affecting our sales with almost 20% on the vehicle side. Very strong service operations. I think it's due to the fact that we have the service operations that we managed to increase the profitability in terms of operating margin from 3.3% up to 4.4%. As we said before, high focus now to this. We have already said that we want to have Volvo Buses as strong about 5% stable. That is the first thing that's important. Historically, I think Bus System being more on level of breakeven, taking it up to 3.5%, got a little bit stuck. Now it's time to move on there. It's a lot of hard work being done here.
I think also we have currency effect is helping us. I think this is the activity that has managed to have negative currency effect, I think, 14 quarters in a row. They deserve a little bit of a positive currency effect. Penta, yes, fantastic result, 19.6%. I was joking with the Penta organization a little bit. Couldn't you manage to take it up to 20%? It only means another SEK 13 million. Would have been nice to have it, but I think that's maybe the only thing that we can complain about, if anything. It's just a great result. Helped obviously by the leaders of engines, but also very good service development. We had a good product mix, a lot of heavy engines, big engines, 16 liters going out to the market.
Of course, to see a result over SEK 600 million for Penta, it's not that long ago that that was the actual full year result. Volvo Financial Services, they are also continuing their journey. We are obviously to the strong markets that we see right now, North America, also the fact that Brazil is coming back and China as well. Increase in the portfolio quite a bit. One year ago, it was SEK 125 billion. Now it's a little bit above SEK 140 billion. As I said before, we see more or less growth everywhere. Operating income above SEK 600 billion. Strong and healthy portfolio. Continued delivery on return on equity. It's once again a solid result from Volvo Financial Services. By that, Martin will come back on stage. Thank you.
I think it's time to open up for questions. We're going to take turns. We're going to start on the floor. We will take questions from those who are participating over the phone. Who would like to begin?
Thank you. I'm Gary Cohen. I have two questions. The first one, you want to pose more questions on this. You get one from me on the defect emission component. My question is really, to the extent that this leads to a material charge or fine in a way, would you expect that if this isn't resolved or if you haven't been able to estimate the cost of this before you propose the dividend for this year, will you be citing this as a key reason for holding back?
First of all, I think you should divide those two questions. First of all, obviously, you know the cycle of our discussions regarding dividends. Normally, or not normally, it will happen this time as well. The board, and obviously in discussion with management, will propose something in relation to Q4 reporting. There is where we are when it comes to the timeline. When it comes to, so to speak, the degradation now, I think it's important to understand that we understand the root cause, and we also know what solutions we will put in place. Because this is a degradation over time. This is not something that is happening at equilibrium, something like that. What we are working with is to understand what could be the potential population in those affected segments and applications and geographies.
We would like to be precise, that we should be when we are giving a figure. We have the arms around this situation, and the details that are out in the market is working accordingly, obviously, to the democracy that is in the market. I will not speculate today about the timeline, of course, we are as eager as anyone else to really clarify furthermore. We don't want to do that without quality in our message, so to speak. That is going for, as I say today. We will not wait if it's not necessary.
The second question is on Renault in market share in Europe. It's up a bit, but it seems as if the progression there and the recovery of lost market shares from mid-term is moving gradually slower than you've been targeting. What's the reason for that? Could you do anything to speed it up? I assume you do, but what's holding it back?
No, it's done. Put it like this. I think it's important to say that the first and most important was to really stabilize, and stabilize the level with good quality in business, because we have a great product offering, we have great service offering. The good news is that in the key markets of Renault, we have done that in a good way. We are actually steadily increasing in those markets. What we need to do now is step by step, also come back to certain key markets where we actually did lose some market shares, and that we're working on. We will not do that to the expense of the quality of the business, because that has been hurting the Renault organization before.
Now when we are standing on three solid legs, because here we're talking about the heavy duty of just south of nine percent, but we are also making progress in the medium duty, and we have a very good progress also on the light duty. If you really put the activity around Renault, I think we have good progress according to plan, actually, and not to the expense of making bad choices when it comes to the profitability for Renault.
Thank you. Let's take the first caller we have online.
Thank you. Our first question comes from the line of Klas Bergelind of Citigroup. Please go ahead. Your line is open.
Yes, I'm marking along. It's Klas from Citi. A couple of questions, please. Firstly, the guidance on Europe. Yet another 300,000 a year when we look at 2019. I just want to understand the reasoning. We're seeing trade volumes peaking, cost inflation building for the carriers. We see diesel up, wages up, that could put pressure on carrier profitability, then fleet age is now below five years. The replacement cycle seems to be over. 300,000 to me can feel a bit of a stretch. If you could comment a bit about how you think about Europe.
Yeah. It is the same message that we have had before. I agree that there are also elements in the market that obviously can put pressure on the haulers profitability. Having said that, we should also understand that they have a historically good profitability level when we talk to our customers, that I think is also a good starting point also for next year, if I put it like that. Another factor that we have seen is that a big part of the, we have almost anticipated that it could be even higher volumes already this year. One thing that has hampered that growth rate has been the lack of drivers, actually, and really to find other type of solutions.
I think there is anyhow a pressure that volumes will continue to because you have some structural measures also, as we have said, for example, with e-commerce, et cetera. If the midpoint in the historical trend line should be maybe 175, 180 or 270, 275, I think we are rather a couple of percentage points higher given the structural change in Europe also when it comes, for example, to e-commerce. Again, when we look at activity level, when we look at our mileage from different sources, the connected trucks, et cetera, when we talk to the customers or to the customers' customers, yes, some sort of stabilization that we have guided for, still we are forecasting relatively solid levels.
Okay. My second one is on the drop-through in trucks, the operational gearing. Yeah, well done. Now almost firing on all cylinders, but I am interested in what can happen on the way down, obviously. I guess, particularly on the service side, if we see demand falling, deliveries might be stable next year as you guide, but orders are facing a very tough comp, particularly in North America. Can you remind us all how the service business worked in North America in 2015, 2016 when vehicle orders were in free fall? North America often used by you as an example of how you improve profitability versus the previous cycles. Any word on service development in the downturn now, that would be very helpful.
North America, as an effect of our strategy to go more and more for captive drivelines, and obviously the fleet that is increasing them with more and more captive engines and gearboxes as well. We managed very well through the downturn between 2015 and 2016, actually. If you look upon us historically in Europe and other parts of the world as well, as a matter of fact, service is very stable in downturns. Maybe not continuing to grow, but at a stable level. We are convinced that it will be a very good support if and when the market turns down. Referring to your point, Klas, 2015, 2016, and the downturn, one important part why we continued staying back in North America was thanks to the increased penetration in services captive.
Captive powertrain, but also that we have been working a lot with uptime centers, et cetera. When you look at North America, we have a market share, maybe 20%, 25%, due to lack of bay capacity historically. Our dealers are continuing to invest in new workshops and new bays. We are more efficient in turning around, so to speak, the vehicles through this certified uptime bay concept where we actually are decreasing turnaround time dramatically. There is a lot of very specific activities ongoing that makes us taking back the market share of our own fleet, basically, of Volvo Mack.
My final one is on the changeover in Mack. You say a very strong order book, booked out for entire next year. Obviously when the transition is over and Anthem starts to deliver, the market share in theory should jump quite a bit there. When do you think you can see a more normalized situation? Is it on this side of the year or do we have to wait until the first quarter 2019?
First of all, maybe you overread it, I said that the order book is next year, it's considerable part of next year, I should say.
Okay.
That is good enough, I should say. I should be even more worried if it was the whole year, actually, given quality in the order book. Having said that, this is, as I said, for Weissburg and the team over there, the main priority right now. As I said, reception of the vehicles is great. High demand, not at least on highway executions that when we previously with Mack, we have had a pretty weak offering, actually. Full focus on that. We are continuously seeing an improvement. You see year-over-year, we have increased also Mack. We are improving, it is a tough situation right now with the competition among everyone to get the attention in the full supply chain here. I can promise that this is full focus.
Thank you.
Hans.
[Anders Bouvin]. I have two questions. Starting off on the European orders second quarter, there was a big difference between the OEMs in terms of order growth. You have Scania and Volvo reporting negative orders, MAN was up quite a lot. As I understood, there was a couple of large orders in Poland and Germany. I was wondering if you could share some light on order activity third quarter, given that you reported 5% growth in heavy. A bit on coming back to Europe, if you could talk also a little about current situation regionally, Central versus Northern and also Southern Europe, because there's a big difference in aging there if you look at some replacement back in the southern part of Europe. Thanks.
We thought with the difference between second and third quarter, when we look upon it, and here we have been working for a couple of years now to have good quality in the order book and really see what is happening, et cetera. As you know, we have a big active part, at least on the Volvo Trucks side also, so we have good control of that. I should say that when we look at the quarter three, and that can also include the regions, we have a relatively good spread, both when it comes to segments, customer sizes, and also geographies. Also when we look at the used situation, actually, in Europe, stable and solid. Generally speaking, we feel that the good activity level continues, and not specifically only for certain regions or customer segments.
All right. Let's move back to our callers.
Our next question comes from the line of Graham Phillips of Jefferies. Please go ahead. Your line is open.
Yes, good morning. A couple of questions, please. First of all, just back on the NOx issue. Can you give us a little bit of idea, Martin, please? You said you're implementing solutions. Is it via software or hardware fix? Has this got some similarities with what Cummins had to deal with back in August? When you do have to account for this from a financial perspective, will it be something that will be in terms of higher warranty charge? Will it be a one-off number in a quarter charged against trucks? How should we think about that?
Yeah. Again, as we said, this is a component that is originally designed to last over the complete life cycle or life length of any vehicle or machine. In some specific cases, we see that there is a risk of not doing so. In that case, it's not about software, it is about the hardware, and we need to upgrade that and replace that in that case. There are different type of solutions of doing so, depending of segment. I think, again, what is important for all of you to understand, it's an isolated problem that we understand. We have solutions to put in place, thereby, I think you should more think about that as a one-off rather than going concern.
Okay. Again, did you look at the Cummins situation and where they had to make a similar fix, I think, on their end in the U.S.?
We did look at the Cummins situation. Obviously, we look at all competitors in all different matters, but I have no specific comments to Cummins. We are working on our issues. What we are, so to speak, proud about is that we have been very transparent. We detected it internally. We have disclosed it. We have had the right context. We are taking action. We are taking our responsibility when it comes to our customers, and we have a good view on both the problem and the solution, and that is what we are focusing on.
Okay, thank you. My other quick question was on the drop-through margin in trucks. Can you give us an idea of pretty much the R&D capitalization? How much was the R&D capitalization to trucks? Was it pretty much all of that? Given that the numbers coming out quite healthily, looks like about 27%, and there's more to go for was your comments a couple of times about the leverage. That means on flat volumes, in fact, we could be looking into next year maybe at a higher drop-through margin?
Starting with the capitalization, the majority of the capitalization accounts obviously for trucks, actually. I think it's more or less virtually everything that is related to trucks. I think what I said was that we still have disturbances and increased or elevated cost levels due to the fact that the supply chain is both internally and externally, it's not working as it should do in normal circumstances. Maybe there also with a little bit more of a stable situation with these high growth rates, I think there's room for improvement from an efficiency point of view if you look ahead. I think all other things being equal, that's the healthy for our margins and what you call the drop-throughs.
Mm-hmm. Can there be more capitalization in 2019 compared to 2018?
We always guide for the next year in terms of capitalization when we come to Q4, actually. I will not go into that today. As well as we don't do that for currencies either.
Okay, thanks. Just finally, looking at the Volvo book-to-bill situation in North America, very high, 2.3 times. Again, you made the comment about the quality of the order book. Are customers prepared to wait that long for a truck when they're ordering, and they can see that it could be maybe into 2020 before they'll get a vehicle? You're not willing to add capacity?
I think, Graham, to your point, that's the reason why I also said that, you have a mix in the order book of firm orders, and then you have certain placeholders. Some of the big kids, for example, we are working with, they want also to make sure we know that they have a certain need over the year. That can vary a little bit, but the basic need or the baseline is already there, and then we are working with them on that so we can distribute that over the year. What we are doing is that when we are rolling the order book ahead of us, we are also going through that month by month, both Volvo and Mack. Not only North America, by the way.
This has been one of the prime focuses over the last years to really get the relation between the order book, deliveries, production, and the value chain much tighter than we have had historically in the group. That is giving results. I think you should think about it as a reflection of confidence also into the market, both from dealers, but also primarily from customers that know that they need capacity.
Okay. Thanks very much.
Johan Danielsson, Danske Bank, before coming back to this, on the NOx situation, you keep telling us that you identified a risk to some components. Are you telling us that you have not had trucks out on the streets being on the wrong side on what the regulation says?
What we are saying is that this is a degradation issue that can happen over time. In certain issues, we have already changed the box. Now we are much more in depth analyzing why did that happen. Very small, big numbers of that, but why did that happen? Because there can be a number of different causes to that, everything from mechanical failures to this type of degradation. Again, what we are saying is that if that is happening, we are changing, obviously, because we need to comply with the limits that exist on the market. When it comes to the disclosure and discussion about the figures, again, we would like to be certain about the magnitudes. We have a serious response to the market instead of guessing, and that is what we do right now.
Yes, cool. Coming back to a potential slowdown in the market, apart from the service side, what are the big changes from last time it went south? What kind of actions can you implement, or are you looking at?
I think a number of things here. Reaction time is the key here. Now I'm talking generally, so don't take this as we are having a sign of what is going down. We also always leave good saying, but if the safe zone, let's say, in the station is, say, -20, 10, then flip the list when you plan for the production. That is how it works. You need to be bold when it starts, and the reaction time is number 1. Number 2 is that you have the flexibility in the system as such, that we have when it comes to temps and fixed contracts, also the flexibility in our value chain together with our suppliers.
How does that differ from last time on the?
I should say that not only in figures, because that is not differing so much. The preparation, where you have the flexibilities, you really can take it out. One thing is that you have a mix between fixed and temps, but another thing is that the consultants or the variable costing in manning can really be taken out from the system, and that we have been working with a lot. Again, I think that both Brazil, the downturn, North America, and also the Volvo Construction Equipment case have shown that we are capable, and we are humble, and we are looking at this all the time so we have a good preparation. I don't know if you want to add something.
As I said before now, we see obviously some cost increases in some areas, and what we try to do all the time now, make sure that what we have on now is really flexible when the downturn comes, and we are also mapping that quite carefully. Coming back to your point, from experience, reaction time is actually a pretty big thing, because if you wait too long, you don't have the right signal, then that is over. If you are prepared, know what to do, act in the right time, and also, if you see things starting to happen, it will be bigger. Take a pretty abrupt thing, because it usually is the best thing, because people are always a little bit more optimistic than what you think.
Another thing, to the point, to your answer, I think also the cultural shift, decentralization gives also pair. That is automatically also giving closer signs to the organization that you really take the decision out in the regions or in the brands, and really act quicker because accountability is there to do so. Yeah. The only proof in the pudding will be when one day that happens, and we can show that we can do it.
We are prepared.
We are prepared.
Operator, please go ahead.
Thank you. Our next question comes from José Asumendi of J.P. Morgan. Please go ahead. Your line is open.
Thanks very much, José, J.P. Morgan. I just want to come back to the Europe as we prepare for the downturn next year. Can you just give us a sense of the temporary workers you have? One, two, how many do you plan to lay off by the end of the year? If that is at all going to happen or not. Then three, can you just give us a figure on the reduction of fixed costs that you've done in the European business this cycle versus the previous cycle? The second element would be please around your product mix. It looks like on order, heavy trucks are definitely suggesting about a 35% improvement in product mix, going on to the next quarters. How sustainable is that share of heavy trucks in your business model? If you could just give some color maybe across regions.
Obviously, we haven't seen yet the impact of Mack in the U.S. long haul. Thank you.
Okay. On the first, José, I think it's a little bit exaggerated to call it a downturn. What we are saying is that we believe now we are guiding up from 310 to 315 for this year, and that is really the fine-tuning when you're coming at the end of the year to see where it will end. It might be some small correction on that in 2018. What we are saying is that next year likely to be on a stable and good level of 300,000. That is, if you calculate it in an Excel sheet, down -5%. In reality, that is what you are taking with the flexibility you have in your production system as it is with banking hours and also the takedown.
Given that type of stabilization to -5%, beyond that, obviously, we have the flexibility needed, and beyond that as well. Absolutely. I was not really sure about the second question, José, if you can just repeat what you meant there about the
What I meant, if you look at orders and deliveries, and you look at the share of heavy trucks within your business. It looks like it is suggesting that the share of heavy duty within your business, both on deliveries and on invoicing going forward, will take an additional bigger share within the truck division. This obviously, I think it's an element that could be a surprise for investors as you continue to deliver record truck margins for the coming quarters. In other words, I think there's a product mix element also coming through for you on the truck front. Is this a level that you think is stable? Obviously we have not seen yet the impact of long haul Mack yet.
Okay, thank you. Now I understand. Thank you, José. If anything, you can say obviously two elements of that. Historically, it has been a drag for us, if I am being very clear, to have the mix into North America reorders, it has been heavy duty. The good news is that we have constantly been improving that situation for North America. The first answer to that is that an increased share in North America is not necessarily bad to us. That has been historically, but a good situation. The second part is that when North America is increasing, by definition, that is heavy duty because we are all only into heavy duty when it comes to North America. If you look at the cost, the share of heavy duty in relation to others will increase.
Thank you.
Let's take one more from the room.
Hi, Martin Lee, Deutsche Bank. Coming back to the emission issue there. Could you say something about your geographical mix in those problems? Is this more in U.S. or is it similar to in Europe as well?
What we have said that it is a segment and applications both affecting North America and Europe. Again, also that is what we are working on now to really understand the different patterns we see, since again, this is wear and tear over a pretty long time period, since they have very good reasons also, by the way, those demand that it should withstand through a long period of the life cycle. That is exactly what we are investigating.
Do you use the same supplier for all your engines?
For the time being, we are not commenting on, so to speak, how the supply chain looks, because what we feel is very important now is that everyone that is part of this really take the full focus of working together to have a good grip on the situation, make sure that we are, so to speak, solving or understanding better the population. As I said, the root cause and the solutions we understand together. Now we need to continue to understand the pattern so we proactively can make sure that the customers can run their operation in good mode, so to speak.
Then a quick one on China, I guess, on trucks there are some emission, tougher emission standards coming out in 2020. Do you see any pre-buy impact already?
It could be. There are two elements there, Martin. First of all, 2020 China 6 or equal to Euro 6 is coming into play in China. What is interesting is that the bigger cities are not waiting for that, because they have so high demands on complying with air quality. Many of the bigger cities actually are demanding that already from mid 2019, which means that we foresee a certain type of pre-buy already in 2019 for the bigger cities.
We have room for one more caller, operator, please go ahead.
Thank you. Our last question from the phone comes from Alok Gupta of Société Générale. Please go ahead, you have one in sight.
Hi, thanks for taking my questions. I just had a couple really. One is on the U.S. Now, just wondering if you could elaborate a little bit more in terms of how, let's say, you're thinking it has developed for 2019. I was just looking at how strong the ordering rates are, and even if we sort of adjust for some speculative orders and a bit more normalization of the order rates, 310, or let's say a bit more than that, still seems a bit, let's say, soft than what the orders would suggest. Just wondering, what is it that's driving your thinking around the 310, or let's say even 320 or whatever it is, for 2019? That's the first, I will follow up on the R&D.
Yeah. If anything, as we said, of course, we have a very strong order book, to your point, and also a continuous strong order intake. I agree, even if that could be, in some case orders, as Ben said, we foresee with activity levels we have now strong 2019. As I already said also in the presentation, if anything, 310,000 could be on the lower side. We think it will be restricted also about how will, so to speak, the supply chain, generally speaking, keep up with these high activity levels. Yeah, we certainly agree there, and we have discussed that where should we put the full cost here. We want to guide that it's a continuous good market that will move more than the fine-tuning is seen to be seen here.
Right. The supply chain supports then I just wonder again, just on supply chain side, if the supply chain's geared up for 300, then 310 seems like a small jump, or even 320, 325 seems like a relatively smaller jump. What's really, is it just your visibility that you have at the moment? Do you want to be a bit more cautious going in? Or really high confidence-
I think the main message there is really, as we said, a strong solid market right now. We are not seeing any signs that should soften off. When we talk to customers, activity levels, when we look at the connected activities, when we look at the order book, et cetera, when we look at the changes in the market driven, for example, by e-commerce, there is a lot of signs. We have guided for 310,000. Might that be on a little bit the lower side? Might be so, but that is the figure we are guiding for the time being.
Okay, fair enough. Then just on the R&D, I'm sorry, I appreciate you wouldn't want to guide on FY 2019 overall, just wonder, just conceptually, how should we think about the R&D capitalization versus amortization cycle as we look into the next 12, 15 months or thereabouts? Obviously for this year, it's probably looking more like a SEK 1.5 billion tailwind. That's 40 basis points roughly on the margin. Just wonder how we should think about where we stand in terms of the capitalization versus amortization cycle, so to speak.
I think after careful consideration, I think I give the same answer as before. We do not yet guide for 2019. I will not do that today. We always do that when we come to the first quarter next year.
Okay, fair enough. Thanks.
All right. That's a wrap up. Thank you so much for coming today, and see you in three months time.