Ladies and gentlemen, welcome to the Volvo Group report on first six months 2014. Today, I'm pleased to present Olof Persson, CEO. For the first part of this call, all participants will be in listen only mode, and afterwards there will be a question and answer session. Speaker, please begin.
Thank you very much. Most welcome to this telephone conference. We will do as we have done previous reports here now that we will have just a very short introduction, and then we will open up directly for questions and answers since the material has been available to you both on the web and also the press conference and discussions. Before starting, I would just like to, because there has been some discussions around the profit improvement program, the SEK 9 billion up until 2015, and just let me recap the situation and what we have been saying and trying to say all the time. We have, as a general target, to, over time, improve our performance with 3% margin.
That is a non-ending target, meaning that over time we will then work through so we can, regardless of the different cycles we are in, having a 3% higher margin than we previously have had. That is a target that is a long-term target that we then work towards over time. We have the SEK 9 billion program, which is then a strategic program running from 2013 to 2015, where I have, together with the management team, identified, quantified, and also set up a number of targets for the organization to be achieved by end of 2015. This is relating to profitability, but it's also we have targets around HR, we have targets around technology, and that has also been communicated and presented to you. That is the 20 targets strategic plan that we do have.
Those SEK 9 billion savings and improvements that we want to see is coming from a number of different things. One is, of course, cost savings, and there we talk about our efficiency program, for instance, but it's also regarding increasing our gross margin and profit improvement, as we have talked about in the press conference earlier today and the margin improvement that we have seen. That is also a part of the program going forward. Those SEK 9 billion will then be materialized over time at a certain pace, and that pace was presented in a curve to the Capital Markets Day in December, where you can see then how much per year, and that adds up to, for instance, during this year, we should see improvements in the range of SEK 4 billion, and then leading up to end of 2015 to the SEK 9 billion.
That is when we refer to the program and when we refer to the SEK 9 billion, and if we are ahead or behind, that is the reference curve that we do have. That curve, as you can see, if you have seen it, but if you see it, that curve starts then the 1st of January 2013. That means that the SEK 9 billion improvement is then based on the 2012. That's the base and how we measure it. Then we have also a baseline, and that is the SEK 300 billion. Basically, we have the SEK 9 billion, and we have the SEK 300 billion in turnover in improvements, and that relates then to an improvement of 3%. I'm sorry if there has been some misunderstanding about that, but I hope that opening clarified the program and how we measure it.
With that, I was not planning to have a long opening, as I said, other than I think the key issue with the second quarter and the way the second quarter has developed is very much related to construction equipment in China and related to trucks in Brazil. These two items have had a considerable negative effect on the result during the quarter, and the improvements we see in other parts of our organization from the efficiency improvement program and the SEK 9 billion program has not been enough to offset that. As I said, I think you have read the material, I suggest that we move into questions so we can have a dialogue on the issues that you find important and the questions you want to have answered. Operator, by that, please open for questions.
Ladies and gentlemen, if you have a question for the speaker, please press 01 on your telephone keypad. We have a first question from Mr. Alex Whight from JP Morgan. Please go ahead, sir.
Yeah, thanks. I've got a few questions. I'd like to take them one at a time. The first question, actually, just on your opening comments there, you talked about a 3% sort of improvement over time. If I look at the average group margin since 2000, it's been around 4.4%. Should we take that as meaning that you're seeking a 7% to 7.5% group margin average through the cycle if we take an extended period of time, and then when we have fluctuations when the cycle's high and when the cycle's low?
I think the way we're looking at this, as I said, there is no time or deadline on this one. The way I look at it is that if you go back historically and see in a high cycle, we had a certain percentage. At that point in the future, we should be 3% higher than that point. You have another margin at the low of the cycle, if you look at that, we should, over time, be able to be 3% higher than that. That's the way we're looking at it. We're basically moving the profitability curve in the highs and the lows in the market upwards on a parallel movement of 3% units. Again, this is done over time, we don't have any deadline on that.
Okay. Then just on the call this morning, I think you talked about a SEK 500 million year-on-year savings benefit from the program in Q2 at the group level. I guess the question is how much of that would have affected the Truck Division? Then the second part of the question is how much should we expect to see in Q3 and Q4 year-on-year?
The majority of that comes into the Truck Division because that's the major part of the program. The part of the efficiency program is valued for a bigger part of the group. The majority comes to trucks. When it comes to the second half, we will continue to focus on cost savings. We don't guide exactly how much is quarter-over-quarter, but it is, of course, a part of this curve that we follow up towards the SEK 9 billion.
Okay.
We could perhaps add to that if you look at the curve that was presented at the Capital Markets Day, we committed to improvements of SEK 4 billion this year. If we look at the curve after the second quarter, we're slightly ahead of that curve. We do have, in particular, on the margin improvements on new sales, we then have an improvement, we're also following in the plans when it comes to the cost reduction. Yeah, okay.
Sorry. I guess since you put up the curve in December, you've obviously had your negotiations taking place in Sweden and in France and in Japan. I imagine you've got a better idea now of how much savings we should be expecting to see in the coming couple of quarters. I think there's obviously some concerns today about what's going on behind the scenes and what's really changing at Volvo, given the magnitude of the missed at least first consensus expectations. I guess some guidance or rough indication would be helpful.
I think, if you see the reduction of white-collar people, we have done 1,200 people out of the 4,400 the first half of this year. We have the Swedish VLP program, 530 people will leave mainly during the third quarter. There are also other measures in the group that make people leave in the third quarter. We have France and Japan voluntary leave programs that comes in the fourth quarter, mainly, and a little bit of an overhang into 2015. As I said earlier today, we are 100% committed to deliver on these 4,400, and we have done 1,200, and it will be done in the first part of 2015, with the majority leaving this year.
How many are the France and Japan then? Is that the balance?
We are 4,400. We have taken out 100. We are going to make the majority of 4,400 this year with a little bit of an overhang. What does it mean? We have taken out less than half so far, which means that we have to do more in the rest of the year, and then with a little bit of an overhang into 2015.
Okay. Then the last question I had around the savings target was, that's an absolute savings target. Is that the way we should think about it, and then we should have cost inflation to consider as well?
Yeah, that is in terms of number of employees, and of course, you have a normal salary increase as well underlying that you have in all countries. The absolute is the number of employees.
Then the SEK 9 billion is an absolute number as well, or is that a net of inflation number?
The SEK 9 billion is a net number. That is the number that we have committed to be achieved by end of 2015. It is a composition, as you know, of targets we have set and then a so-called headwind factor to take care of different aspects of the business that we have going forward. That's how we come to the SEK 9 billion.
Just a final add to that. Johan explained it very well. There are two parts. We have regular employees, which we talk about the VLP programs and all of that. Of course, we also have consultants that we are addressing. In this new structure, we are actually changing the organization as well to get more efficiency. If you look at the staff and support functions, we are now implementing a completely new, more efficient structure. That is also something that you need to, in the Swedish legislation, the French legislation, and in the Japanese also to negotiate. It is not only the reduction per se, you also need to negotiate the structures. That is exactly what we have been doing now, and that is why we will Consultant side. It is a total reduction, both fixed and consultant.
Okay. Just on that, the normal wage inflation is what, 3%-4% for the group as a whole or?
4% is on the high side, I would say.
4 is on the high.
Yeah, that's on the high side.
If we have 3.5% over three years on a SEK 36 billion base, you're running at nearly SEK 4 billion of added costs from wage inflation. We should be thinking about an absolute level of savings that's at least SEK 13 billion, probably a bit more if you've got other cost inflation as well. Is that how you think about it?
How did you come to the 13?
If you have a salaries base of about SEK 36 billion, 3.5% of that is SEK 1.25 billion. It's a three-year cost program, so we have three years of cost inflation, which takes us to SEK 3.8 billion. If we add SEK 3.8 to the SEK 9 billion, then we get to just shy of 13.
Yeah. I think this is a fairly technical calculation you're doing right. I think as we said before, I think what Olof mentioned before, the SEK 9 billion we have included headwind there. It is the absolute savings that we're going to do, net of inflation, going forward.
Okay. Thank you.
Next question comes from Mr. Martin Viecha from Redburn. Please go ahead, sir.
Hi, this is Martin Viecha from Redburn. I have just a bit of clarification on the restructuring program. Does this mean that the 300 basis points margin improvement plan is different to the SEK 9 billion profit improvement plan? Am I understanding this correctly that by 2015, the total profit achieved will be 2012 profit plus SEK 9 billion?
What I have said a number of times is that, what we are committing to is based on 2012. We will have on those areas which we have specified, and you can see that yourself. It's in the sales and admin, and it's in the gross margin, it's in the R&D, it's in the IS/IT cost, and so on and so forth. In those items, we will improve based on 2012 with SEK 9 billion. Compare those items by items, we will have an improvement by 2015 of SEK 9 billion based on a SEK 300 billion turnover. I've said also, because I've got this question a number of times, and I've been clear on it, we don't know the margin in 2015, because we don't know the currencies and other things as well there.
We are committed to that by the end of that year on those items, we should see an improvement by SEK 9 billion. On those items, it would be SEK 9 billion better. Is that clear?
Yeah. That's perfectly clear. Secondly, are we talking about two different plans here, as in the 300 basis point plan and the SEK 9 billion plan, or are we talking about the same thing?
I think that the SEK 9 billion plan is a very important piece of the puzzle to achieve the over time 3% margin improvement. It is a very important piece of doing that. Of course, we will continue after 2015, to continue to improve and do the necessary things we're doing. In general, you can say that the SEK 9 billion strategic plan is a plan up to 2015, 3% over time regardless of the cycle, is something that will come over time. The SEK 9 billion plan is a very important piece in achieving that.
Okay. Thank you very much.
Next question comes from Mr. Alex Potter from Piper Jaffray. Please go ahead, sir.
Hi, guys. I wanted to switch over to China if we can. I was wondering if you think the, I guess, market-wide difficulties that China's facing right now might force some of the Chinese competitors out of the market. Do you think over the next year or so when you see these, I guess, increased competitive problems, inventory, things of that nature, will that drive those companies out of the market?
It's difficult to say, but if you look at historically, it depends on the market size to start with, and we don't know exactly what the market will pan out being a sustainable market, for the Chinese market, and that will depend also how many players. If we go back in China and look at what has happened over many years, and if you look at the wheel loader business, and there you can see that there has been a consolidation, a substantial consolidation over the last 10, 15 years. There was a huge number, and I really mean a huge number of small local players doing wheel loaders in China up until, I would say, 2000, and then up to 2005, and so on. There we have seen a real consolidation. Will that happen again? Might be so.
It depends on the market sizes and so on and so forth. If it happens, it will take some time. I don't think it will happen overnight. Definitely committed to the Chinese market, and we will make sure that we do what we can in order to stay in our place. Then it might be that we see more consolidation in the market going forward. A little bit based on history and experience as well.
Okay, very good. Then I had two questions on North America truck. The first one is on cyclicality. Obviously, we've seen very strong orders here. Do you think there's any risk that we're pulling demand forward into 2014, and we potentially see the cycle peak out earlier than we originally expected? That's question number 1. Then question number 2 is, earlier on the call, you mentioned that you're working on trying to improve the profitability in the North America truck market. If you could just boil down to maybe the 1, 2, 3 types of things that you're doing in the near term, to increase margins in North America truck, that would be very helpful. Thanks.
Sure. I think one important factor with the North American market right now is that up until now or up until recently, it has been a replacement market. We haven't seen any growth in the market. Now we do see a sort of expansion also into a new expansion of fleets and so on and so forth. That is, of course, much driven by the economy development in the market. Therefore, it will have a lot to do with the GDP going forward in the North American and U.S. in particular, how that is developing. I think that will be a correlation back to as it normally is between GDP freight volumes, then also expansion or contraction in the North American market. We'll see how that develops.
When it comes to the profitability in North America, there are two areas where we focus mainly on. One is to really making sure that we capture aftermarket business based on our higher penetration on I-Shift and engines. Also, and I think it's important to remember, is to provide a better service totally. We have moved a lot in the North American market to work with telematics in order to improve service offers to the customers. The whole area around maintainability, service, and the business around that is something that we focus a lot around in order to improve and increase the profitability in North America. The second one is, of course, also that we need to work on, if you look at the brand and the brand position that we have, both with Volvo and the Mack.
We are addressing the Mack brand with a relaunch of the brand, a rebranding. That is also important in order to connect that to product features, and that is also something we do. I would say these are the two major areas that we're working in. The second area you could put under the heading of actually having a rightly positioned product in the brand position, but also a very competitive product in order to increase the profitability.
Okay, thanks very much, guys.
We have next question from Mr. Ashik Kurian from Goldman Sachs. Please go ahead, sir.
Hi, it's Ashik from Goldman Sachs. Just have a follow-up question on your clarification on the SEK 9 billion cost savings. That you've clarified that you're using 2012 as a base for that, if I recollect correctly, in 2012, you also said that your margins were hampered by around SEK 1.5 billion or so of launch cost. Is the reversal of this also part of the SEK 9 billion cost improvement by 2015, or should we see a normalization of the launch cost on top of the cost savings coming through?
The launch cost was primarily, I would say, heavy in 2013, but we also had launch cost in 2012, of course, but mainly in 2013. When it comes to the selling, and that is particular on the selling side, the targets we have set, as you can see in our story, is actually a percentage of the sales. That means that we are reducing the wholesale, which is the back office point of view, and therefore the launch costs are very much also on the retail side. In general, you can say that we have taken height for that in the SEK 9 billion in order to accommodate into the SEK 9 billion. The answer to your question is that the savings you see is the savings that is part of the SEK 9 billion, which also includes savings coming from the launch costs.
Thank you. Very clear.
We have next question from Mr. Fredric Stahl, UBS. Please go ahead, sir.
Fredric? Are you there operator?
Yes, we take next question from Mr. Andreas Brock from Nordea. Please go ahead.
Thank you. Two questions, if I may. First of all, on China CE, market was down, you were down more than market, you were down 30, market was down 19, if I recall correctly. Could you help us understand what happens in such a massive downturn, both in terms of how the local customers think about brand, how they think about price, how they think about financing, and what are the main challenges now for your sales in China? Two, also on the gross margin improvement, which is happening in Europe, how is the increase in price on Renault side have? Is that doing just as well as on the Volvo side?
If we look at the challenges on the VCE side in China, of course, one of the reason that the market is down less than our deliveries is the fact that we have sort of stopped delivering into our dealers. That means that, like we had in Brazil, that the sales that goes on is actually from the dealers out to the market, which means that our sales goes down. Again, this is the right way of addressing it, but it is a correction that is costly but has to be done. If you then look how the customer react, well, it is of course a difficult situation for the industry as a total all the way out to the end customers. I think what is very important now is to look at that we have a good control of, that we measure and see the machine utilizations.
We have a good sort of sight on when the market is coming back, and how it's coming back and where it's coming back, and what kind of models are starting to move again. We also have to make sure that we are monitoring the whole flow of system when it comes to the dealer inventory to make sure that that is actually coming down. It is a market which is, of course, down, and by that, also affecting the whole of the industry. The key here, I truly believe, is to have a lot of people on the ground to really feel and be there to react quickly and making sure that we do the right decision when we start see things moving again, when that will come.
When it comes to the gross margin improvement and on the Renault side, it's still very early days, the pricing on the Renault side has been accepted. We have seen that going forward now. When it comes to our offer to the customers, we are looking, of course, on the price and the margin, but it's also on the service agreements and financing, and that creates a package. So far so good when it comes to pricing on the Renault side as well, even though it's early days.
Thank you. Just one final follow-up there on VCE in China. I know that you have some off-balance sheet guarantees made to the, I believe the banks in China that are financing your construction equipment sales. Have any of those off-balance sheet items, are any of them impaired? Are the banks forcing you to stop paying them for, i.e., some dealers, et cetera, have gone bankrupt?
Far there's been no call on guarantees on Volvo.
Fair enough. Thank you so much.
Ladies and gentlemen, I remind you that if you want to ask a question, you will have to press 01 on your telephone keypad. That is 01.
Okay, operator, if there are no more questions, I would like to
There are no further questions at this time, please go ahead, speakers.
Okay. I would like to thank you for joining the call, and I hope by the introduction that I clarified some of the issues that was discussed during the day regarding our saving programs. At the end of the day, I just want to reemphasize for us, we are totally committed to making sure that this program is executed. We are on plan. It is a fundamental part in our commitment to increase the structural profitability of the Volvo Group. This is something that's not done from one quarter to the other, but I hope that you can see now that we start to see the positive impact. In this quarter, those positive impacts, which starts to get quite sizable, was not enough to offset the negative that we had in CE in China and the trucks in Brazil.
It shows to me and the rest of organization the importance of this program in order for us in the future to be much better prepared to be able to cope with those kind of swings. That we will continue to see in the market going forward. We are in a volatility. With that, I thank you much for calling in. I wish you all a good summer and talk to you again on the third quarter release. Thank you very much.