Morning everyone, welcome to this press conference covering the second quarter of 2016. On stage today, we will have our President and CEO, Martin Lundstedt, and our CFO, Jan Gurander. As we all know, this is a webcasted event, so please use microphones during the Q&A session. Martin, why don't you start?
Thank you, Gina. Good morning everyone. Loyal audience here today. Welcome also from my side for the quarter two reporting. Go straight into the report here. Quarter two was another solid quarter for the Volvo Group. We are on track when it comes to our cost savings, when it comes to our internal efficiency programs, but also when it comes to the implementation of the new organization that we will come back to a little bit later on here. Despite that sales decreased with 7%, 3% excluding FX and divested units, the underlying performance of the business improved from 7.1% to 7.8%. In particular, the global truck business reached 10% operating margin, excluding the provision that we made during June for the European Union investigation.
When it comes to volume development in the second quarter, truck volumes were down with 5%, whereof Volvo down with 9%, in particular than U.S., -39% that couldn't fully be offset by Europe, that was up 17%. Renault up 12%. One, of course, strong factor during the second quarter for Renault was the pre-buy effect of light commercial vehicles, Euro 6 pre-buy, that coming into effect now as of third quarter. Light commercial vehicles were up with 18%, and that is also a little bit disturbing the order figures for Renault when it comes to second quarter. Mack down 22%, that was better than Volvo for different reasons, but the main reason, of course, that Mack is less affected by the downturn in U.S., since the downturn is mainly affecting long haulage and to a less extent Mack core segments of construction and vocational trucks.
UD flat. For machine deliveries in construction equipment, down with 16%. Volvo in total flat. Europe is actually moving ahead in a good way, +22%, whereas North America, South America, and Asia for Volvo is declining. SDLG then heavily hit by the fact that we had a pre-buy effect in quarter one, Tier 3 legislations coming in, -46%. Of course, that is continuing to be a tough situation in China. For service sales development for the group, 3% excluding FX up. It's too early to say that we have a positive trend here, but as you know this is one of the main focus areas for us to really focus on the rolling fleet of different equipment that we have out in the market.
If we look into the different business areas, excluding currency, trucks are up 3% in sales. We have a flat situation on Volvo Construction Equipment, which is also I think a good development given the recent years of decline in volumes. Plus 2% in buses and actually plus 15% for Volvo Penta. In total, we are moving in the right direction also with the service sales. This is one area, of course, that we will continue to deepen in our analysis moving forward. Very important for us also the Group's resilience to volatility. Coming into trucks, we see a continuous good demand in Europe, good momentum. For Brexit, that is an obvious question. Of course, we have no major visual effects of Brexit so far. Good pace in Europe. We are keeping down our forecast that we will come back to.
We see also continuous correction in North America from the very high levels that we have seen in the recent years and specifically then in 2015. A third bullet that is important for us, as from 1st of March, we have a new organization, brand-based truck organization in place. Gradually during quarter two, we have got that more and more operational. Manning all the different executive teams. We are working with the business plans, and that is moving in a very good pace and with the transparency motivation that we had predicted and hoped for. That is positive. Before coming into the figures, some minutes on the news in the truck segment for Volvo. We have presented an upgraded version of our Euro 6 engines, together with also upgraded I-Shift functionality, meaning that we are getting even more efficiency when it comes to fuel consumptions.
For the 420 and 460 D13 liter engine, it's about higher compression ratio that is giving a more efficient combustion. For the high-end 13-liter engines, 500 and 540 versions, we have new optimized turbochargers in place. Together then with new functionalities on the I-Shifts, we see fuel improvements in typical long haulage applications up to 3%, which is a major step. Also for special applications such as heavy haulage timber, even more actually because there we are also adding new functionality, unique functionality with our I-Shift, meaning that we can cover even more captive units with our I-Shift for crawlers, for example, where you're standing still with very high loads and also liftable tandem, meaning also that when you're not fully loaded, you can better use only two axles instead of three axles, and that is also gaining fuel efficiency.
We're also introducing a new aerodynamic kit on the FH executions, both when it comes to defectors, bumper shapes, et cetera. This is a very strong and good package moving forward. When it comes to the services, as I said, one very important part is in North America, where we are driving an efficiency program together with our dealers. As a matter of fact, a little bit interesting maybe for you, and many of you already know that the average waiting time in the industry for trucks is three to four days, actually, up front the dealer for an average repair of three to four hours, which is, of course, not a situation that is good for an uptime for the customers. Industry average, we have been working very focused.
In October last year, we announced the fact that we are going to work with a new concept with uptime centers, meaning that we have a couple of different flows in the dealers where you have repairs less than three hours. We have specific flows for that in order to have a better throughput time. Very good results so far. As we speak now, we have 32 certified uptime centers for Mack Trucks, and in many of those, of course, combined with Volvo Trucks. Results are astonishingly good, actually, when it comes to throughput time, efficiency, and also thereby the opportunity for us to get more jobs to the workshops. As a matter of fact, we need that also given the pace of the captive powertrain penetration also.
Together then with our connectivity penetration with Mack GuardDog, for example, or also for Volvo Dynafleet, this is a very important measure. When we come down to the market environment and start with North America, we see that the current pace in registrations is somewhere 240,000-250,000, actually. Since we also see that the stock reduction is taking off, but it will take at least the rest of the year, we are keeping a conservative view on the total market. We are lowering the forecast from 250,000-240,000. Minor adjustment maybe, but it's a strong signal that we are prioritizing also quality in the business. That is the new forecast. For Europe, we have a continuous good momentum, and our expectation is that the market will land on somewhere around 290,000, and that is the forecast that we're also keeping from quarter one reporting.
As I said, we have no strong signs of Brexit so far. Brazil, the same forecast also. We are running on a very low level, 30,000 total market. Main priority, obviously, in Latin America is to keep also tier 1, tier 2, and tier 3 structures for our suppliers because we are running on very low levels now, and many of our suppliers also have difficulties to maintain with that low pace, not only for us but for the whole industry. At the same time, and we'll come back to that also, we are doing commercial activities in Brazil, not to gain volume, but to gain momentum when it comes to pricing. For Asia, where we are seeing a China that is better, even if it's too early to say that it's really taking off.
But what is interesting to see is that the e-commerce, for example, is taking off in a good pace, and that is affecting the total market. We are increasing forecast to 820,000 from previous 750,000. India is on previous forecast levels as well as Japan that is on a high level and forecasted to be also this year 90,000. Market shares, just to start with, we have been very clear also to our organization. Main priority now is not really to hunt market shares without maintaining the right quality when it comes to our different deals to our customer base because we have the necessary scale already in the system, but with good quality, we will grow eventually also with our customers, and we will grow with quality. That is, so to speak, the standpoint and the general direction that we are heading for here.
Even with that, actually, we are also moving in a positive direction. When it comes to North America, we had a very slow start, as you remember, in quarter one. For Volvo, after the first quarter, we were in a market share on 8.4%, and after quarter two now we are up to 9.6%. Quarter two was significantly better than quarter one. Obviously, also Volvo is affected more than Mack by the fact that long haulage is taking a bigger hit in North America than vocational segments. That you can also see in the market share of Mack that has been increasing from 7.2% to 7.8% here. In Europe, we have a flat situation for both brands, you can say. Volvo on a historical high level, around 17%.
We see also that we need a little bit more capacity in Europe, and we will adjust a little bit upwards here. Also for Renault, we are now bottoming out and keeping a flat level. What is really important for us when it comes to Renault is to keep quality in the business, price realizations, and also that we see that the residual values, given the very good offering we have now with Renault, is coming in on the right position. Also one very important factor for us with Renault is to keep also the right level when it comes to the industrial system so we are having the right absorption. As a matter of fact, with the levels we have, we can maintain it. Japan, a little bit same situation as Volvo in North America.
Slow start in quarter one, we were at 15.7%, now we are at 16.4%. Several reasons to that. One internal, we were changing system, classic, but we are back on track there now on the production systems. In addition to that, it has been also shortages, for example, in body build capacity. When you have production disturbances, as we have in quarter one, that is also affecting your position in the queue with body builders. We see a better Q2, we are also leaving Q2 with a stable situation here. Also South Africa and Australia are developing well here. Orders and deliveries, again starting with North America. For orders, a little bit scattered picture. Volvo is down with 44% from then dealers into our system.
One explanation, of course, is that the market is continuing to shrink, and we're coming down from high levels, but also that we actually now see an accelerating stock reduction from our dealers, which is good. A stock reduction that we didn't really see during quarter four and quarter one here. Mack is up 13%, that was really due to a super weak quarter two last year. That in turn was also an offset from a strong quarter four the year before that. That is also showing a little bit of volatility and taking out speculations, et cetera. Priority in North America now is to find even better balance between production, thereby deliveries, order intake, and stock.
Main priority, as we said, the right balance and to follow also with a good cost flexibility to the volumes here. Our estimate is that it will take up to a year to clean out the stock and to have the right level here. My feeling is that we are managing this in a good way and with the right priorities. Europe orders also a little bit of different pictures. Volvo is up 5%, Renault is down 11%. You can say two different explanations for that. In heavy duty, we are down 7%, mainly explained by the fact that we had a pretty pushy sales activity during quarter two last year.
When we see the levels we are running on order intake that is given approximately the same market position as we have, we are pleased with that and to concentrate on the right quality in the business. Then obviously on light commercial vehicles, we also have a downturn, and again, based on the fact that we had very strong order intake in quarter one up front Euro 6 legislation for emissions. Production adjustments in order to cope with this, we are increasing production slightly then for Volvo, mainly in Tuve, Gothenburg. We need that balance when it comes to more heavy specifications. We are slightly adjusting down Renault in order to have the right balance for correct absorption also of the industrial system. In South America, total market, as we said, down. Our estimate is from 42 to 30.
Thereby also we need to continue to work with the right output, keep stocks in good order. We are also actually realizing some price increases, pretty aggressive price increases. As market and image leader, you need to take that responsibility. In Asia, mainly then UD unchanged. We see for Volvo a slowdown mainly in Middle East, Saudi, and Turkey. Otherwise, we have pretty good momentum in, for example, markets like Korea and China for Volvo. Then for Africa and Oceania, we have orders coming in positive from Australia, Algeria. Algeria is also on the negative side of deliveries because there it has been also homologation issues, but now deliveries have started to come back to good levels again. On construction equipment market, we see growth in Europe.
We see a slowing North America, specifically then on general purpose equipment, larger machines related to oil and gas and mining, a continuous weak situation in emerging markets. The big volume drop, as we said, for SDLG related then to the post Q1 volume drop in China after the introduction of Tier 3 emission levels. Also what is positive for us as we see mainly down in Europe, a continued market share gaining for larger machines. That has been the focus for us during the last quarters here. Also another introduction that we are conducting that will also change the game in the construction equipment segments. That is Volvo Co-Pilot, where we are investing in even better human machine interface.
We got actually an award for the core and core, interesting, but they are actually Car HMI Award in Germany, in Berlin 2016, for the best human machine interface in the automotive sector. That shows that we are on the right track. Even more important when it comes to the Volvo Co-Pilot is the specific applications for different segments, in order to improve productivity, compliance and not at least safety, because you can control much more from the cab or the cabin in itself, rather than to step in and out as the operator. We have for loaders, what we call Load Assist, we have Dig Assist for excavators, Pave Assist, et cetera. What it's really about is that you can, in a good way, control not overload, not under load, the right angles, better productivity, better load time, et cetera.
Very interesting concept that will gain ground in the coming years here. Big interest from the markets. On the market environment, mainly unchanged forecast as from Q1. What we see in North America is a flat development so far during the year, but general purpose equipment or larger machines, negative related to oil, gas and mining. In Europe, we had the forecast of 0% to +10%. Until May we are up 7% in total market, where France, Scandinavia and Germany are moving ahead and Russia and U.K. weaker. In China, we are also maintaining forecast from -15% to -5%, but we also start to feel that we can be close to the bottom actually finally here. We see some signs of better utilizations of machines. This I think is also something that we need to follow very closely now during the coming months and quarters.
For Asia, excluding China, you can say lower activity in Korea and Japan, but India, positive momentum. Coming into orders and deliveries for construction equipment in North America, what we see is orders -6% and deliveries -11%. For us they are mainly related to the larger machines where we have stronger positions, and that is in that perspective related to oil and gas, as well as product exits that we did between Q2 last year and after Q2 this year. In Europe, what is positive is, as we said, the momentum in the market, but also that we are actually gaining market shares in larger machines. Also positive for Volvo here is France, Scandinavia and Germany, where Russia continue to be very weak and also a slower market in U.K.
Brazil continue to be very low, as we said about trucks, about damage control, and not at least for ourselves, but also very important together with our suppliers. When it comes to Asia, you can say that the slowing situation and pretty big figures here is mainly related to SDLG then after the introduction of Tier 3 in Q1. Buses, also a positive trend for us after a weaker Q1. As you remember, we are back on track on our trend of improvement for buses. Order intake improved by 33%, deliveries up with 28% in the quarter, driven down by North America and Europe, which is positive for us. Just as one example here, we have been taking a number of interesting deals.
One that we maybe didn't want to mention in terms of volume, but another order for fully electric buses into Luxembourg, but where we are not only delivering the buses, but also the complete system and infrastructure. That is a trend that is very important. Another example is the successful hybrid buses in London. I don't know if you know the exact figures here, but you have around 6,000 double-decker buses in London, where of actually 3,000 of them are with Volvo chassis. Of these 3,000, almost 1,000 today are hybrid executions. 30% of the Volvo market share is with hybrids, and that is showing that the hybrid electric mobility in different levels are moving in a better pace now.
It's also, given obviously, substantially better performance when it comes to environmental output, but also when it comes to noise that is very important in big cities. I think that is showing also that we are on the right track here. Finally, some comments on Volvo Penta. Orders down 2%, and when you are talking about a pretty wide range of engines, that depends on what engines we are talking about. As you see, the slowdown has been on marine leisure gas engines in North America, smaller engines. We have had good growth in the off-roads engines on the versatile side. From a product mix perspective, of course that has been positive, even if we have had an order and delivery decline here.
We are continuing to launch, the Easy Boating c oncept where we are taking care more and more of the full, so to speak, care of electronics and propulsion, and maneuverability for boating. That has been a success and will continue to be a success. One example is the e-Key Remote now where you can control the electrical equipment from the dock. Also the new eight-liter engine with IPS drive also. That will be a success following also the other IPS executions that we have. Good pace also for Volvo Penta here. With that, I will leave the floor to our Deputy CEO and CFO, Jan Gurander, for the financial figures.
Thank you, Martin. Good morning. The second quarter, as Martin said, I think it's fair to say that we don't get very much help of the markets. I mean, sales are declining and maybe stable and a little bit down. We see also that pricing is not easy, if I put it that way. Despite that, we see that we improve our results for the group. I think that is due to the fact that we now continuously see that the internal measures that we are working with continue to yield an effect. I think that's really proof of how important it is to work with efficiency in a group like this when you don't see that you get this external help from the markets.
When we look into the net sales, it fits actually perfectly with what we see in terms of sales figures and where the markets are going. We have, of course, Europe coming up in terms of sales, while you can see all other market areas are declining. Of course, the biggest decline we have in is in North America. We go from SEK 85 billion in sales down to SEK 79 billion in sales. We have a negative currency effect of almost SEK 3 billion. We do also have an effect, actually a small effect though, but from divested entities. One of the things is, of course, the external business that we had in IT that we divested in the beginning of the second quarter. Sales down 7%, excluding currency and divested entities is down 3%.
Looking into the operating income for the different areas, here, of course, we have this one-time effect, I should say, second quarter last year with the capital gain from the sale of Eicher share, so a little bit more than SEK 2 billion. In this quarter, we had the negative effect of the provision connected to the European Commission's investigation of SEK 2.3 billion. If we exclude these factors and look into the underlying performance of the group, we go from SEK 6 billion up to SEK 6.1 billion, increasing the EBIT margin from 7.1% to 7.8%. We can see here that all areas, with the exception of the Volvo CE, is improving year-over-year, the results. When we look into group functions and other, sticks out as on the negative side. Here we have the transition cost for the outsourcing of IT in the second quarter.
That will continue also a little bit into the third quarter as well. We had a headwind on the currency of approximately SEK 300 million. Looking into the different lines and the P&L, here you can see the volume effect comes in affecting our gross income with a negative of SEK 900 million. Here though, what we have here, it's actually a positive effect coming into the gross income and into the gross income margin. That is due to the fact that we see actually that our material cost is coming down. It's on the positive side. We also see that the logistic cost comes through as well. I think we are focused very much on our structural SEK 10 billion program, that continues to kick in. You can see that here also on the selling and on the admin side.
We also have other effects that we're working with that are not kind of structural, these start to yield an effect on the gross margin as well. You have the proof in that when it comes to material cost and also, as I said before, the logistics cost. On the negative side, obviously, volumes, currency. When we talk about currency, we said in the first quarter that we had, as you know, the transaction exposures and the currency effect, given the volumes or the flows that we saw last year, we said it was going to be, at that point in time, what we saw with the currency, a negative somewhere between SEK 2 billion-SEK 2.5 billion. When we look upon the currency rates that we had at the end of the second quarter, we think the negative effect will be slightly lower than SEK 2 billion.
Once again, remember the high volatility that we see in the currency market. This is an estimate that we do based on these assumptions at the end of the second quarter. When it comes to capitalization and amortization, the effect year-over-year is a positive or a little bit less than SEK 300 million. We have now for the first two quarters capitalized more than what we have amortized. This will now turn in the other direction in quarter three and quarter four. If you take the net of capitalization and amortization for the full year, we think it will be virtually zero or on balance. Turning from a positive effect quarter one into a negative quarter three and quarter four. The cash flow is SEK 6 point, almost 7 billion.
You can see here that the discipline that we have in terms of when it comes to the investment level, as we talked about, we talked about it in London. We are well invested to take in this company, and we don't see a need for that. We said that the levels that we see on the PP&E and so on is the one that we should keep, and that is what you see here as well. In the second quarter is the quarter where you usually have a positive effect from the payable side. First quarter is negative, second quarter is positive on the payables. Third quarter usually turns in the other direction again. You can say that this is more or less a cash flow that is according to what you can expect from a second quarter.
Of course, the underlying profitability helps us quite a bit. Looking into trucks, the deliveries of trucks down 5%, and the sales when we currency-adjust it is down with 5%. We see here that vehicles pretty much affected 8% down currency adjusted, but then we have the positive effect on the service side on trucks up 3%. All in all, going from SEK 57 billion to SEK 52 billion in sales. On the operating income for trucks, we go from SEK 4.4 billion, once again, taking away these two one-time items and of course last year also taking out the effect from the restructuring charges. From SEK 4.4 billion to SEK 5.2 billion, and going then from an operating margin from 7.7% to 10%. This quarter we managed to take it to 10% as well.
On the positive side, we have the effects of the restructuring program, SG&A, lower material cost, and of course then the effects on capitalization of R&D. We see also here, which is a little bit of a mathematical effect, nevertheless, it's a positive market mix that we have, i.e., that North America take a lower share of our sales this year compared to last year, and Europe is bigger, and that gives us the market mix effect. On the negative side, volumes and currency. On the CE side, delivered machines down 16%. Here you can see that on the Volvo brand in CE, we are pretty stable, more or less flat, while we have this pre-buy effect that affected us in the switch from the first quarter to the second quarter, and it's a negative 46% year-over-year.
This, of course, with the higher value that we have on the Volvo machines, you can see that the sales are actually down with only 7% when we currency adjust it. The sales value 1 SDLG machine is much lower than the Volvo. That's why it doesn't come through so much on the sales figures. Service is flat for CE. Sales totally down with almost SEK 2 billion. On the operating income side, you can see here that we go from SEK 1.3 billion down to SEK 800 million, margin-wise from 8.8% to 5.9%. Obviously the lower volumes are what is affecting us here on the CE side. We do have small positive effects. There were many, many small positive effects, but really no one that was so sizable to mention on the positive side.
The efficiency programs also works through here in CE as well. There is a lot of hard work ongoing. As I said, not one single thing that was qualifying to be on the positive side here. Buses, as was mentioned before, delivered 28% higher unit sales compared to last year. Sales then were up currency adjusted with 17%, positive both vehicles, also service positive. Here I think what is important going forward is now that to capitalize on the growth that we see within the bus area. Of course, higher volumes gives us a positive effect on the P&L. It's also important now that we maintain our cost base and to be able to fully utilize the leverage that we get from the volumes. That is actually what we see here in the first quarter.
We managed to take care of a 28% growth while maintaining. Actually the programs that we work with there on the cost side are also kicking in. I think that is important. It is important now to take the bus operations up to a higher level, but also to keep that higher level stable as well. We have had a little bit too high volatility on that one. So we are particularly happy to see now that first of all, the trend that got a little bit of a hiccup in the first quarter continues up to close to 5% now. That journey will continue. A little bit the same as, of course, not the same kind of sales growth that we see in Penta as we do for buses.
We can see that sales are up with 6%. History service extremely strong here in the second quarter, up 15%. It's the same thing here, the story as we have within buses, that we do improve our profitability with the higher sales, then also here then to maintain and keep the cost base going forward. Once again, a quarter with, I think, a more than decent EBIT margin. Financial services, not very spectacular in the quarter. This is actually keeping its profitability around the half a billion SEK mark, generating a return on equity of 13.5%. Actually continue to manage the downturn in South America in a good way. Also I think as a whole, a good quality in the portfolio. Even though the markets out there are pretty tough in terms of pricing and so on with the low interest rate environment.
I think this is a solid operations and a solid result for all the financial services. I think as I started to say, and I think also as Martin Lundstedt said to begin with, that it is actually improved through profitability on lower volumes due to the internal measures that we are working with and that yields effect, and basically that I think we are on our way. Martin Lundstedt?
Coming up again. Thank you, Johan. Just to summarize very quickly, another solid quarter. Cost efficiency programs, internal focus is moving ahead according to plans. What is important now, of course, and big focus for us is also to continue to pursue the new brand-based organization, full P&L responsibility for those brands and also for Volvo Trucks, obviously, which is considerably bigger, that we continue to drive that decentralization also through the regions. We feel that we have good enthusiasm and drive in the organization, a big deal of motivation actually coming in here. What we have said is really to work with four themes. Based on this is use what we have. We are well invested. We can do much more of that. The service focus, big installed fleets around the globe with very good presence in the network. Quality, quality.
That is the best business plan we can have. We are in a good way protecting customers, but in some of the products, in some regions, too big a cost internally. Finally, continuous improvement and use the competence of all great people that we have in Volvo. I think that is, Johan, the summary of the quarter, and we open up for questions.
Thank you very much, Johan and Martin Lundstedt.
Thank you. Björn Enarson, Danske. A question on European demand looking ahead. You are now taking up production at Gothenburg slightly. Given order intake and, I guess, concerns for the business cycle in general, not only trucks, how are you looking at the truck cycle in Europe? Where are we, according to you, your expectations? We are at a pretty high level, and I guess we are approaching some kind of peak.
First of all, the adjustments we are doing, a slight adjustment, as we said, upwards. We are moving in with a half evening shift, you can say, in Tuve. A couple of reasons for that. Get better balance between the different application and specifications levels we have in Ghent and in Tuve. We have seen that for some of the specifications, we have had a little bit too long lead times, and those are also specifications with good profitability, so that we cannot have. Secondly, also that Tuve is actually also supplying a big part of overseas markets. For example, China and Korea are 100% sourced from Tuve, and they are doing well, coming from relatively small volumes, but starting to get some sort of Korea, obviously, but also China.
This is not only about Europe when it comes to the production adjustments for Volvo, but total and keep lead times where it should be. Having said that, we are doing that also with a high level of flexibility, obviously. We can move forward also depending on what market development will look like. It is true that there are a lot of different uncertainties, but our feeling is that we have the right flexibility with the brand-based organization, the regional organization. We are working very close when it comes to the handshakes between regions and the different plants, not accumulating big figures up with me and Johan, put it like that, but really where it belongs, and that will also drive better flexibility.
When it comes to Renault, we are actually moving down a little bit, not because if you really see both sequentially and quarter on quarter, not really because we are feeling that we are losing volume, but we have said that for Renault, it's better to be a little bit on the low side for the absorption and to use flexibility upwards. There we are doing a slight adjustment downwards, not a big one. We are talking considerably less than 10%, but having the right balance. I think we are doing the measures needed there.
Thanks. One last question on, you highlighted as one of your slides, the volume impact on EBIT for the truck business and also a few other items. Lastly, also on the mix impact. Should we read that slide that volume had the highest impact and mix the lowest impact?
Yes.
Possibly?
Yeah. We used to put it in order of magnitude.
Makes sense. Thanks.
Thank you, Erik. Kristian Nordea . I have three questions. The first one on services, 3%, I think, organic growth on trucks. Some color there on the regions, Europe, North America, South America, particularly. Second question is on the credit losses for construction equipment, China. Will we be at this level for the rest of the year into 2017? On how long we will see those losses coming through? The third question there on the lower material costs. I know you've mentioned a number of initiatives, could you say anything about specific gains for your three-year savings coming through there? Thank you.
I can start with China. I wish I could give you an answer, because this is an evaluation that we do continuously month by month and look through, of course, what is happening in the market, what is happening with our dealers and end customers. I think it's maybe too early to say that it's over. I wish I could say it was, but we're probably not there yet. The magnitude in each quarter is difficult to say, actually. I think it's actually more of a coincidence that it looks fairly stable. It's more a coincidence than it's actually reality. We check every month the dealer's health and so on. The material cost. This is, of course, an effect of the program.
You remember that we started in 2012, 2013, actually. As I said before, we have focused quite a bit on the structural SEK 10 billion. The underlying other activities that we do actually yields an effect. This is the hard work that's been done in the production organization and in our purchasing organization, that start to come through. We also, of course, have some help from the fact that raw material prices are supporting as well. It's a combination of our own abilities and raw materials as well.
On services, it is mainly Europe and North America where we are seeing that we have improvements. It's too early to say really 3%. We should be also a little bit humble and say, let's see the trend first. If you really see the potential for us, given the fleet size, the differences also between segments and geographies in Europe and also in North America, there is a substantial potential to drive this. North America is a specific case, as we said, because in theory, we have a bottleneck situation with our dealers. Therefore, our market share is pretty low, actually. The Uptime Center activity that we're doing, for example, is to increase throughput, higher volumes in the installed base that we have. In addition to that, we are working with our dealers also to enhance capacity, basically.
We are also using connectivity to a big extent to take out some of the work that should not necessarily be done in a workshop, diagnostics, software updates, et cetera. There are a number of very good activities. North America is more, how do we get the asset to sweat even better, actually? There, the thing is that customers have to wait too long time, basically. Not only for us, but the whole industry. Here we have a great opportunity. In Europe, again, what we see is that when we are driving, for example, contract penetrations, both on repair and services, Volvo Gold, Volvo Blue, and also for the different levels for Renault, we are also driving penetration. The potential is still good. Those are the two markets with the biggest potential and where we also see these improvements to start with.
I think one of the important aspects where we are doing this disclosure more separated is, of course, for you to have better transparency and see what we are doing, but also for all of us to keep this in mind in the organization, that here we have a lot of good potential.
Is North America growing faster than Europe?
Yeah. Obviously, the question was if North America is growing faster. Again, I think it's not fair to take one quarter and draw too much conclusions of it. We see that we have plus 3%. This is good, but the proof is in the pudding a number of quarters down the road.
Of course, looking on the potential in North America since the rolling fleet of Volvo Trucks with captive and drivelines is increasing all the time. There, just mathematically, the potential is bigger there than what you see in Europe, of course.
In four days we Q also. I mean, come on.
Hampus Engellau, Handelsbanken. I also have three questions. Starting off with the profitability in trucks, 10% EBIT margin. Have we now seen the full swing of savings, or are there any additional savings coming in? Could you maybe talk a little bit on the margin, maybe give some indications on where you are regionally and also by brand? Second question is on market share. What do we need to see to have the Renault market share coming back to 10, 11% in Europe? Is this a France issue or how should we think about that? Last question is on the run rate. If you could maybe indicate where run rate is today in North America and how that compare to deliveries. Thanks.
Starting with the 10 billion program goes according to plan, as you know, that is financial-wise finalized by the end of this year, there comes more saving. I think that is what we have seen over the last couple of quarters, actually, is that other underlying things, as we said, we don't focus so much on it, internal work, efficiency work, that we also see coming through in the gross income margin. I don't see any reason why that should not continue. How we now are shifting from these structured reduction programs into the continuous development way of working, actually, that should also, of course, continue to yield an effect when we move into 2017 and onwards. I think you can definitely expect that now coming through.
When we look into the profitability on brands and regions, of course, when you improve the profitability from 7.7% to 10%, it is a broad-based improvement that we see. Obviously, when you talk about Europe, talk about both brands, Latin America is a separate chapter. The downturn that we've seen in North America, of course, means that the profitability goes down there. I think as you understand, when the underlying profitability, I think we manage that in a good way.
It was only necessary to use one color.
As a whole, broad-based improvement actually, and where we see the severe downturn, I think we managed that in a good way at the same time.
One comment also on, just to add on what you all said about the brand-based organization, it's pretty interesting to see now also the first business plans coming out also, how much more, so to speak, focused on the customer-based geographies and, so to speak, the core business of each brand is coming out again. I think that is also very positive effect of this initial work that has been done during second quarter as well, so to speak. That in combination what you said, and yeah, there are a number of other aspects that we can come back to. On Renault, what we have said there, and as I said also, is that obviously Southern Europe, that is the core markets, and France we own 27%, and there is an upside.
At the same time, we have said we should gain that upside with quality now, quality in the business. We have a very good product. We are working on different aspects in order to drive that. Well-received, right price realization, right RV realization is more important because if you think about it, there is often a quick conclusion that we are sub-scale to Renault. If you really think about the full product and that we are running one final assembly, we own not that sub-scale actually when it comes to industrial system, or we are not sub-scale at all, basically. When it comes to the product, maybe there are some of the components in the new that is a little bit sub-scale. For a big part of the product, it's also pulled out by the whole system.
When you look market to market, there are very few markets where we are under 10% today. When it comes to the distribution and network system, that is country and district by district where scale matters. I think also have that in mind that it's not important for us to come back to 10%, 11% of scale reason and sacrificing the quality in the business. I think that is the main message for us. Obviously, we think that we have such a great offer, so we should be better. That is the hard work that we need to show to our customers and the trust. Run rate North America 250, approximately 245, 250, a little bit if you calculate the current rate times 12 or 11.8 or 11.4, and that you can do a little bit how you like, but somewhere 245, 250.
All right.
Yeah. Hi, Anders, SEB. I have a couple of questions as well. Coming back to the material costs, it's obvious that we saw a very nice price movement last year on raw materials, but they basically turned up. At least steel costs turned up massively since year-end. I think U.S. up 60%-65% on relevant steels, Europe a little bit less, plastics most likely going up, et cetera. When you look into next year, when I also believe the action plan initiated will have less effect, probably, do you expect material costs to actually go up then? Is that a fair assumption?
Can you say anything about pricing development in the U.S.? The market is so weak and after being so for so long. Eventually, maybe it's really going to be a big problem.
Obviously, of course, we have softer pricing in U.S., both on new and on used. A little bit more used. Again, we are doing the same thing in U.S. as we are doing in. We are not hunting the wrong market share, if I may put it like that, even in downturn now. We are not destroying that. Obviously when you have a whole system geared for it and also an overstock, you have price pressure, that's for sure.
All right, let's move over to those of you participating over the phone. Operator, please go ahead.
Thank you. Ladies and gentlemen, if you have a question for the speakers, please press zero followed by the one on your telephone keypad. The first question comes from Klas Wilen from Citi. Please go ahead, your line is now open.
Yes. Hi, Martin and Johan. It's Klas from Citi. I have a couple of questions, please. Firstly, I want to come back to the truck margin. If I take out currency, it's a 40% incremental margin sequentially. I think it's the highest uplift on record. Could we try and break out what drove the improvement the most? Savings appear in line with my forecast. Was it services, the net effect of higher European production versus North America, or was it just a mix of stronger deliveries in high margin Europe?
Pretty much, yes on that.
Thanks.
Klas, the answer is yes. I think it's up to you guys to figure out a little bit what is what there.
The reason, Martin, is that there are obviously a lot of concerns around Europe, if this is mainly driven by geographical mix, then the margin is really not sustainable. I just want to hear your thoughts there.
I think, Klas, just coming back to that, as we said, also what is coming through, of course, what the savings that, if I may say so, that you have calculated that is coming in from the structural cost program is one thing, but also that we are gradually seeing also other dynamic effects when it comes to the cost and efficiency base is obviously a very important part of it as well. I think we have to give credit to the whole work that has been done also internally on efficiency and structure.
Your drop-through in a potential downturn in Europe this time compared to previously has improved, i.e. you're more resilient today?
I think we should be humble here and be very close, as I said, now when we are adjusting production both upwards a little bit then for Volvo and downwards for Renault, even if there are slight adjustments, this is exactly also to follow the market even closer, to see that we have the right balance between variable and fixed cost. I also think that U.S. so far is serving as a good example that we have improved in our way working with the volatility. Again, here we need to be very close and put the foot on the accelerator or brake in the right timing. That is the trick here.
My second question is also on Europe and back to Renault. Was this only the hangover from the pre-buy or was there any underlying weakness, customers concerned about residual values around Brexit, et cetera?
If you take the figures for Renault and you look at both quarter one, quarter two, and quarter two year-over-year, to speak, the absolute order intake, if it's all with heavy duty, I think really that we are maintaining approximately the position that we have now, as I said, the feedback from customers when it comes to the product, the performance, and the operation is good. We are not hunting volumes to the expense of quality in the business right now. That is what we see. We are not in particular worried for Renault from that perspective. We think that we are on the right track to continue to develop Renault in a positive way here.
Good. My final question is on market shares for Volvo in North America. It seems like the second quarter market share improved versus the first quarter when I break out the year to date. Is that correct, and was it mainly an effect post the recall, or did you sense any underlying market share improvement towards the end of the period?
Yeah, I think it was both, actually. Obviously, it was the recall, and that caused disturbances for us. Also the fact that we were, I think, putting the foot on the brake a little bit harder than some of our colleagues in the business. We still think that was a wise decision in the short run. Also that if you look at the mix in quarter one, it was some big fleets where we didn't have maybe the same hit rate. There was a number of things, but we feel that we are coming back to a better level now and that we have the right momentum given the market situation.
Very good. Thanks, Martin.
Thank you.
Thank you. The next question comes from Guillermo from UBS. Please go ahead, your line is now open.
Hi, good morning, Martin, Johan. Guillermo from UBS. A couple of questions from my side, actually. One regarding demand in the U.S.A. Could you describe the progress through the second quarter? Was it stronger in June compared to the two months? I wait for the second question. Thank you.
I think pretty much. June was a rather okay market. If you really calculate that, depending on what multiples you use, I think it was a little bit on the high side from the forecast. Again, one month is very tricky to take. We feel that if anything, that's the reason why we lower from 250 to 240, that is fine-tuning, obviously. We feel that, if anything, there is still a little bit of this down pressure. We will have also presidential campaign and a little bit of uncertainty. Obviously, there are also a number of factors that are positive in the U.S.: housing, construction activities. We see indexes that are supporting this. We see that on the inquiry level also in some of the segments for Mack, for example.
We see also that the inventory correction is not only related to our industry, but a little bit to the U.S. economy in total. There is a year of a little bit of inventory correction as a whole, even if that underlying macro is okay. I think that we lower from 250 to 240 should not be overread, so to speak, but it's a little bit more, okay, where are we here? If anything, is to give a small sign that it could be a little bit lower.
Thank you. The second question is regarding the EU introduction of CO2 emissions, which may be a little bit far-fetched for the set up today, but the limits for trucks by 2021. I want to understand what you think about these standards and what does it mean for your R&D expenses?
If we start with CO2 standards, we already have that, as you know, in the U.S. Since we're using the same type of technology, obviously, we are well-prepared. We also have the same powertrain and full powertrain, both engines and gearboxes, axles, and different type of options. From that perspective, I think what Europe is heading for now, and we are supporting that, obviously, is that we are, in the first run, working on a simulation tool that customers and also customers' customers can actually simulate different type of equipment when it comes to the CO2 efficiency. Again, CO2 is very much driven by the market forces, since that is also related to fuel and other costs. When it comes to the preparation for different levels, I think we are in a good position here.
Thank you. Thank you very much. Maybe I can risk a third one on the demand from the U.K. in itself. Have you seen weakness in the construction trucks in the U.K.?
No, we have not actually seen any particular change in order pattern from U.K. so far.
Very helpful. Thank you very much.
Thank you.
Thank you. The next question comes from Graham Phillips from Jefferies. Please go ahead. Your line is now open.
Yes, good morning. A couple of questions. Just firstly, going back to where you think we are in the European demand cycle for trucks, could you give us an idea how much of the installed fleet do you think is on pre-Euro 6? I'm coming across from the angle that Euro 6 engines seem to be more efficient than Euro 5. A lot of people hung off to understand maybe there's some pent-up demand that could be coming from that.
I think, obviously, we are two, three years down the road with Euro 6, and we have an average fleet age of five to six years, depending on application. That is where we are now when it comes to deliveries. When it comes to efficiency between Euro 5, Euro 6, obviously, we managed to continue to push fuel consumption a little bit down on Euro 6. One should remember that from Euro 5 to Euro 6, it was another very big step on NOx levels and on particulate matters, and those type of emissions are counterproductive in relation to CO2 and fuel. That is like unemployment and inflation in national economy. The name of the game is really to drive by engine development down to Euro 6.
If you really see the fuel efficiency and CO2 efficiency between Euro 5 and Euro 6, there are minor effects when it comes to the efficiency, maybe a couple of percentage points better for Euro 6. Not because it's Euro 6. It's more because of, at the same time, taking down NOx and PM levels. Our engineers are very, very skilled, and engineers have been able also to drive a better technology. As an example that we showed today with compression ratio increases, new turbo technology, better matches with I-Shift, new functionalities, and these type of hard, solid, and fruitful engineering work.
Do you have an idea of how much of the installed base is Euro 6 in Europe?
Don't have the latest. Let us come back to it, but again, it has been introduced now a couple of years here, and the average age is 25%-35% something.
Okay. Just on the balance sheet. We've obviously got the truck fine, the European truck fine still to pay. I think we're going to get some more update on Wednesday. Maybe you can give some color around what the timetable on that announcement may be. Also, have you been paying all the China provisions for the credit losses, or is there any sort of accumulated provision that has yet to be paid. Are there any other things that are yet to be paid, either restructuring expenses that would give a difference between where the net debt position is today and where it could be if we cashed out on everything we have provided for?
I think when it comes to China credit provisions, they are up in the range of, I think, SEK 1.9 billion that we have put aside now during these, what is it, two years. The majority of that is still provision. By far the majority is not paid out yet.
As you correctly said, depending on the outcome in the European Commission, that is obviously nothing paid out.
Right. We don't have.
We don't have any comments or ideas regarding the timetable. As we have said already from the start, in 2011, on this investigation, we have been fully cooperating with the European Union on this matter. They are deciding the timetable, and until then, we will and cannot comment anything but more than we are cooperating, and that we have disclosed the provisions that we have disclosed so far.
Okay. Just finally, you talked a lot about the benefits in service and the growth that's come from the initiatives in the U.S. and some combined dealerships, Mack, Volvo, the uptime service outlets that you've got. Can you contrast that to Europe and how much more efficient is the U.S. dealer network to Europe? Is there some upside that can come from Europe?
All questions obviously has been great, but this is an interesting question because when you are a big group with different regional footprints, you can learn a lot from each other. What we really see, we were with the team actually in U.S. two weeks ago. What we see is that in some of the areas, U.S. is well ahead of Europe. In some areas, as a matter of fact, the other way around. Again, if you can combine these different aspects, we will have even greater situation. When it comes to contracts, contract penetration, for example, we have a much more solid situation in Europe. When it comes to the connectivity, uptime services, how we are actually using the connectivity to drive business and to drive preventive activities, U.S. is ahead.
I think this is exactly what we want to achieve now, working closer in the business also. Interesting potential for the two different regions here.
Okay. Thank you.
All right. That's a wrap-up. Thank you all for coming today, and we wish you all a nice summer and see you next quarter. Thank you.
Have a nice summer. Thank you very much.