Ladies and gentlemen, welcome to the Kuehne + Nagel Q3 2018 Results Conference Call. I'm Sherry, the conference call operator. I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star 1 on your telephone. For operator assistance, please press star 0. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Dr. Detlef Trefzger, CEO of Kuehne + Nagel. Please go ahead, sir.
Thanks, Sherry. Good morning, good day, good afternoon, and good evening to all of you, and welcome to our analyst conference on the nine-month 2018 results of Kuehne + Nagel International AG. Our CFO, Markus Blanka-Graff, and I welcome you from sunny Schindellegi in Switzerland. As always, we will lead you through the slide deck published earlier this morning. As always, we start on slide number three. The success of the Kuehne + Nagel Group in gaining market shares and improving profits continued in quarter three. For the first nine months, the group's EBIT posted an increase of CHF 60 million over last year. Strong volume growth in sea freight were gained with 8.8% or 284,000 TEUs, more shipped in our sea freight networks. Strong volume growth also in air freight, posted with +16% or 180,000 tons more in our air freight networks.
We've seen overland with substantial net turnover growth of 16.2%, and contract logistics with a strong net turnover growth of 10.6%. As always, a short overview on the key KPIs on the following page four. Net turnover, +13.6%. Gross profit, +11.7%. EBIT improvement, CHF 60 million or 8.8%, earnings per share were up CHF 0.33 or +7.3%. I assume it's more interesting to go into the details for you, we continue with sea and air freight on slide five. Sea freight posted strong volume growth in Q3 with more than 10%. It's the second quarter with a growth of more than 100,000 TEU. Or to be very precisely, 112,000 TEU in our networks, shipped in addition to the previous quarter three this year.
The margin pressure continues, we were able to offset this margin pressure by operational leverage and our cost measures, we will come to the details of that very soon. The tremendous success of our air freight operations continued both with the perishables, but also with our industry solutions. I will go into more details on the following slides. Slide six. The success of our sea freight sales colleagues, combined with the excellent performance of our sea freight operators and the sea freight solutions, led to a strong volume growth. This volume leverage supports the high conversion rate of almost 30% in quarter three. We launched two digital platforms end of quarter one, these platforms got a lot of traction with our customers.
The new business wins are based on KN ESP, our digital end-to-end solution. They attract a lot of new customers for the sea freight organization. Our investments in digitization in the sea freight business is ongoing and will continue fast-forward as we see the leverage in the market. With regards to trade lanes, we saw strong growth in exports from North America and Asia. Looking down to the air freight details, we have seen the same strong volume growth in the air freight network from exports from North America and Asia. Air freight successfully deployed our solutions in the pharma, healthcare, aerospace, and e-commerce sector, contributing to an increased gross profit margin. The remarkable performance of air freight is also based on the seamless integration of the perishable acquisitions that we posted in the previous quarters.
As you know, we operate the largest, by far largest, perishable network globally. This attracts more and more customers to get the solutions, the perishable solutions, from Kuehne + Nagel. Let's go into some details of the volume growth on slide seven. Volumes in the sea freight market, our volume growth increased or stayed double digit in quarter three, while the market slowed down in the last quarter. Especially Asia-Europe stagnated or maybe was a bit negative, although all markets show high consumption and high purchasing powers. Our investments into trade lane development and digital platforms and solutions showed the expected traction. These investments we will continue with. The growth that we have posted, the 8.8% or plus 284,000 TEU, equals more than the controlled annual volume in sea freight of some of our competitors.
Only the incremental growth in the first three quarters of the controlled business is outperforming some of the annual volumes of our competitors. With regards to air freight, we have seen also the air freight market slowing down last quarter slightly. Our strong growth is generated based on two facts or maybe three facts. First fact is our compelling solutions. The solutions I mentioned before, KN PharmaChain, to mention one, which were good for 8%, 9% of our growth, and the perishable integration and the perishable solutions for the rest of our growth. We will give more guidance on the market development at the end of the presentation. Sea freight on page eight. Quarter three versus quarter two, you see this on the upper part of the slide. Margins are stabilizing.
They have stabilized in quarter three. Our operational leverage and the operational and the productivity measures show the expected results. We have a stable net margin, EBIT per TEU of CHF 1,992.94. As always, I would like to give you a bit of a flavor of the volume margin and cost effects. In GP, the volume effect in sea freight for the first nine months has been CHF 92 million. The margin effect only minus CHF 7 million. The cost effect through the high volume increase, CHF 67 million. The EBIT improvement, incremental EBIT, sums up to CHF 14 million for the first nine months. These are the aspects that we can influence. On page nine, you find the same details on air freight. Margins continue to improve slightly.
We have posted a margin per 100 kilo of CHF 70 in quarter three, which is mainly driven by hard cargo and our solutions business and a stable margin in perishables. The cost of implementing our new IT software, the AirLOG software, as well as dealing with the high volume growth, showed an operational cost per 100 kilo of CHF 50. On average, we assume that CHF 48 per 100 kilo would be the normalized cost that we expect in air freight. We see a strong EBIT per 100 kilo of CHF 20 in air freight for quarter three. Also here, some details on the margin, volume, cost, and EBIT effects for the first nine months. The volume effect in air freight has been CHF 120 million for the first nine months 2018. The margin effect has been +CHF 26 million.
The cost effects have been -CHF 102 million, resulting into an incremental EBIT improvement of CHF 44 million. Let's move to slide 11, to our overland business. Another record quarter for overland. The improvement in overland is going on. Currently, we see high rates and margins in the market, the highest since December 2016. We also see a strong demand and have a strong pipeline in the U.S., and we expect less of the overheated market for quarter four, but a continuation in the strong demand. Details of the overland business you will find on slide 12. As you know, Q3, quarter three, usually is the weakest quarter per year. Also this year, it's the weakest quarter, but to be clear, it has been the best quarter three for overland in the history of our company, with CHF 40 million EBIT absolutely generated in quarter three.
The performance of the overland business has improved throughout the last quarters. Despite the one-time effect of a disposal of the overland business in Brazil that we informed you about in quarter one, the overall performance in overland is incrementally higher than 35% year-over-year. We always said it's fun to do overland business. Remember, five years ago, four years ago, and with quarter three 2018, for sure, we have proved that this business is a very, not only important part of our integrated solution offering, but as a standalone business, a very profitable and attractive one as well. Contract logistics, slide 13. I have to say, it's also fun and important to do contract logistics business, and you have seen us doing the past years.
This year, and we said so when we posted quarter one results, the contract logistics business is influenced by our investments into new operating platform, into technologies for picking enhancement, into a new warehousing management system, as well as the restructuring of our drinks logistics business in the U.K. All this as planned. Nevertheless, we see a decreasing EBIT year-over-year in contract logistics for the first three quarters 2018, and we assume this will be ongoing for another couple of quarters. On the market side, we see a lot of success in contract logistics. Strong net turnover growth and gross profit growth of more than 10%, and as said before, impacted by the investments into the new operating platform. Where does the growth come from? The growth comes from e-commerce fulfillment.
We have seen year-over-year growth of 40% in new operations for e-commerce fulfillment, and in pharma, more than 20%. All these new wins lead to start-up investments, start-up costs that will be recovered throughout the course of the contractual period. I think that in total, with CHF 27 million EBIT for quarter three and CHF 93 million EBIT for year-to-date 2018, the contract logistics business has done a tremendous job while transforming the whole portfolio of activities. Having said so, I would like to hand over to Markus, who will lead you through some of the details of our figures.
Thank you, Detlef. Good afternoon, ladies and gentlemen. I'm on page 15, income statement. The most important number on the income statement is the net profit earnings for the period. I think what we have achieved in the first nine months is we delivered CHF 580 million net profit after tax, which is CHF 40 million more than last year, or 7.5% more than last year. From my side, we could actually conclude the call at that moment because that is what we are here for. We're here for delivering bottom line and 7.5% increased bottom line for the first nine months is our starting point. Let's look at some of the KPIs a bit closer. We have increased our gross profit by CHF 600 million, and out of CHF 600 million additional gross profit, we have generated CHF 60 million or 10% more EBIT.
That is below our target for 2022, which is a 16% conversion rate for the group. When I look into the quarters, quarter one was around 14%, quarter two 10%, quarter three 6.5%. That is a slowdown, but it is exactly what Detlef was explaining in the investments and the business growth that we are initiating in the contract logistics and also in the strong growth in the sea freight business unit. Overall, a few technical details. We have exchange rate impact that had been a bit stronger at the beginning of the year until the first six months. At the current stage, in the mix that we are having in the currencies in the income statement, we are having a positive FX impact of +2.4%. Tax rate, we're still expecting to maintain a stable tax rate around 23%. Leading to next page 16, the balance sheet.
Only three things I want to highlight. The first one, equity ratio. In December 31st, 2017, we started the year with the equity ratio of 31%. We are now nine months into year after payment of dividends at 28% equity ratio. This is a very healthy equity ratio. This is a very healthy balance sheet. To preempt some of the questions, I know I have spoken about it last time already. There are new components in the balance sheet on the asset as well as on the liability side, called contract assets and contract liabilities. In simple terms, IFRS 16 is requiring a reclassification for this. Work in progress, was it called in the past, contract asset is it called now, and associated contract liabilities are shown at a specific line in the balance sheet.
IFRS 16, the integration of lease commitments into the balance sheet as of 1st of January 2019. For information purposes, so that everybody is prepared, that will add approximately CHF 1.4 billion on both sides of the balance sheet, so an extension to the balance sheet, of which we would expect our balance sheet to have an overall size of around CHF 9 billion. Let's get away from the more technical part into the more real part, cash and cash equivalents, page 17. Cash is all that matters, if you like, and we continue and confirm a very diligent and tight cash management. When you look at the year-to-date results out of the cash balance, you can see that we started the year with around CHF 700 million cash. You will see through the cash flow, three components what reflect our growth strategy, that reflect higher rates within the business.
I'm talking sea freight, air freight rates. The reflection of the larger share of contract logistics in the sales ledger. Especially the changes in working capital. We have put CHF 310 million into the working capital in the first nine months, which is an increase of CHF 136 million over last year, which is driven by the three components that I just said. Kuehne + Nagel is growing very strongly and with large volumes. Hence, volumes growth and rate growth is driving the working capital. Cash flow from investing activity, which is mainly CapEx, that is the part where contract logistics plays a major role, is CHF 167 million in the year 2018, around CHF 70 million over last year, which is CapEx. Last but not least, we paid in May 2018, approximately CHF 30 million more dividends than we did in 2017.
Adding all that together, we have a current cash balance of CHF 218 million on the balance sheet, which is around CHF 350 million below last year out of the reasons that I have just explained. Let's have a bit of a closer look at the working capital, since that is the bigger item. Page 18, working capital intensity, 4.3%, still within our corridor, 3.5%-4.5%, which we have extended one and a half years ago, exactly to accommodate growth strategy. How did we achieve that to remain also in the DSO, DPOs, or on the spread between the DSO and the DPOs around 11-12 days? DSOs, as we all know, customer pressure, DSOs are expanding. It's just the fact of how the industry works.
We are mitigating this pressure with enlarging of DPOs, mainly through our supply chain finance solution that we have developed together with Citibank and has a very good acceptance rate in the industry. Going forward, and especially in the light of tariffs or additional higher rates and bigger volume growth, I see that the working capital intensity will remain at an elevated level. I cannot foresee that the higher tariffs will lead to a lower working capital. That is not logical, and what's not logical is not finance. At the end of the day, we will probably see even more pressure on the working capital interest. Having said that, page 19, and I apologize at least on my side, that page doesn't have a page number. The return on capital employed. We are currently at 60%. 60% is the value excluding the acquisitions.
The mix effect that I have been talking about three months ago is still valid. We have a stronger growth relatively in contract logistics, which leads to a higher asset allocation as it is in the sea and air freight business. As well as the currency effect, which is wearing off a little bit compared to three months ago, but is still valid. No matter what our opinion, how we drive return on capital employed up again to the 70%, which we still maintain as our target based on the business mix and the balance sheet composition, is a simple answer to that question, we will increase profitability. Financial targets for 2018, page number 20. We confirm our targets 2022. Conversion rate for the group, 16%. Return capital employed, 70. Effective tax rate in the corridor, 20%-23%. Working capital in the corridor, 3.5%-4.5%.
The long-term targets, I think, are not impacted neither positively or negatively. We are very well on track to get there. Short-term, and short-term means market 2018. I appreciate that we are mid of October, so that is two and a half months to go. We believe market in the sea and air freight is going to settle at around 3%, which you can easily translate to that there is a slowdown that Detlef has already mentioned. Overland and contract logistics at around 4%. With that page, I would like to hand over back to Detlef for the further part of the call.
Thanks, Markus. While indicators signal lower growth, we are very confident about our own performance. We have proven over the last nine months that we can outperform market growth by factor two to three, and there's no reason to believe that this will change. We are able to control our costs well in order to ascertain the leverage effects that you know from us. Our investments into digitalization as a game changer in sea freight, in air freight, in the contract logistics business units and overland continue and help us to drive better services and improve productivity further. We have shown, for example, with perishable acquisitions that we made, that the acquisitions as an accelerator help to drive the overall performance of the network, as we are able to integrate additional volumes seamlessly in our networks. Our Roadmap 2022 is in full swing of implementation and well on track.
We invest successfully and will continue for the next quarters in the digitalization, new platforms and also eTouch, of which the benefits we will see in the future as per our detailed explanation and presentation during the capital market stage. As promised, dear friends, we will inform you about the details on how much traction we got in eTouch, or we will get in eTouch this year during the next analyst call on the full year results 2018. Based on what we have presented to you and the very good results of the first nine months, our full pipeline of new customer contracts, as well as the cost control programs well underway, plus the investments into transforming our business, we expect to close this year, the year 2018, successfully again. Thank you very much. I hand over to Sherry to open up the Q&A.
We will now begin the question and answer session. Anyone who wishes to ask a question may press star and one on their touch-tone telephone. You will hear a tone to confirm that you have entered the queue. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use only hands to ask me a question. Anyone who has a question may press star and one at this time. The first question is from Mark McVicar from Barclays. Please go ahead.
Good afternoon, Detlef. Good afternoon, Markus. Thank you both very much for that. Two or three questions, really. First of all, because it's a much-asked question this morning, could you give us an idea of the proportion of your air freight and sea freight volume that goes across the Pacific?
Yep. Continue with the questions, Mark. Good morning. Good afternoon to you, and please continue with the question.
Right. Fine. Okay. Thank you. All right, that was the first question, proportion of total volumes on the transpac.
Yeah.
Second question was, you are obviously in the middle of your budgeting process. What are you saying to your people? What are your people saying about the likely rate of volume growth on that transpac route in 2019? How do you work a budget given the uncertainty? The final question is, I took your point, Detlef, that consumer confidence is quite strong in most of Europe. We in the U.K. are waiting for Armageddon, of course. Why do you think those Asia-Europe volumes are down a little bit year-on-year?
Let's start with the transpac volume. We have around 8% to 10% of our total volume is transpac-related. For both sea and air freight, the budgeting process is in full swing at the moment. As said before, there is no reason not to aim for market share gains as well as strong volume growth. We have compelling solutions, Mark. We have solutions that matter for our customers. We have customers moving back. The growth that we anticipate is still, let's say, strong, double-digit. Yeah? Yep. The only insecurity in the market might be quarter one next year. To say this also clearly, as we, at the moment, do not know whether the insecurity of new trade regulations becoming effective January next year might cause some higher volumes to be shipped and stock levels to be increased in quarter four. That is to be seen.
In total, low taxes, high purchasing powers, decreasing unemployment rates, I would say that speaks for high consumer confidence and ongoing investments into consumption. I think the third question, Mark, what was that again?
Yeah. Given that Europe is actually in pretty good shape at the moment, why do you think the Asia-Europe volumes are flat or very slightly down, as you rightly said?
Asia-Europe, I think it's the consumption pattern has shifted slightly. There has been a strong double-digit growth on Europe, North America, so vice versa. Some of the sources for consumer goods have shifted. Is that a permanent shift? I wouldn't say so. You know that some of the Asian economies have concentrated their market on Asia as well. We benefit. We have strong double-digit growth on inter-Asia. We benefit from the overall market development. On this trade, at the moment, we see this to be flattish maybe is the right word.
Okay. That's great. Thank you both very much.
Next question is from Sathish Sivakumar from Citigroup. Please go ahead.
Good afternoon, Markus and Detlef. I have a quick question for you. Do you see any changes to your dividend policy on the back of free cash flow coming in well below the dividend for this year?
Sathish, we had problems to understand your question. Can you please ask again?
Yeah. Do you see any changes to your dividend policy on the back of free cash flow coming in well below the dividend?
No. Sathish, we had been, obviously, conversations between the boards, and I think we have a very healthy cash flow. At the current stage, we have not discussed any changes in the dividend policy, which, to remind everybody again, is between 75% and 100% of the net profit after tax.
Okay. Just on that follow-up, do you foresee any long-term targets around free cash flow coverage of dividend? Because you said you're just discussing with the board.
It is natural, obviously, that we are updating our board on a quarterly basis with the supervisory board meetings on the financial performance of the group. That is where, obviously, that is discussed. There is no such discussion going forward.
Okay. Yeah. Thanks very much.
All right.
Next question is from Damian Brewer, RBC. Please go ahead.
Good afternoon, everybody. I've got one question, please. I just wanted to come back to the air freight business. Given you've had significant expansion in the perishable business, which one would expect to normally be both GP and margin dilutive, can you talk a little bit more about what the air business would've looked like just on the non-perishables and give us a feel of what's gone on there? Clearly, the industry platforms have helped, it'd be interesting to get a little bit more flavor of what's going on under the surface there. Thank you.
Good afternoon, Damian. Our air freight business shows improving margins in the non-perishable sector. I said so when I went through slide nine, I think it was. When we post or when we sell our solutions, because we usually sell end-to-end solutions and have reflected the specific industry and customer demand in those solutions, we are able to have a robust or even a strong margin for this business, while perishable stays at the moment on the known much lower margins.
Just as a follow-up, if you're able to characterize your business on the air side, how much of the volumes you handle would you say are perishables nowadays versus non-perishable volume?
Our perishable business is good for around 32%-35% of our total volume. Again, this gross profit or the margin per 100 kilo is flat, while the improvement in margin is due to our investments into solutions business. KN chain solutions, as we call them, KN BatteryChain, KN PharmaChain, Secure Chain, KN InteriorChain for the aerospace industry. We have a lot of those solutions up and running, they drive both volume growth, as customers are extremely interested in those solutions, also stable or improving margins.
Okay. That's very helpful. Thank you.
You're welcome, Damian.
Next question is from Daniel Roeska from Bernstein. Please go ahead.
Tom, good afternoon. Looking forward to Q4 and more detail on eTouch. Would you be willing to share progress on eTouch and what the current penetration rate across the two main modes, air and sea, are? Secondly, you, of course, talked about the continued investment into the different businesses. Could you give us some more color when you would now expect those investments to end or at least decrease again? Thirdly, that of course, I would assume translates into improvement in conversion, but could you break the 13%-16% increase on the conversion rate you're targeting into broad buckets? How much of that is eTouch? How much of that is lower investments and what the other components may be? Thanks.
Sure, Daniel. Let me start with your first question. We presented the eTouch mechanism at the Capital Market Day in September, we started the whole Roadmap 2022 nine months ago. To answer your question, you will all get details altogether in our end of February call on the overall 2018 performance. Here we will detail eTouch, not only structural but also by business unit. The penetration to see this also clear is slow at the moment because we still invest into the full eTouch and automation, digitalization of the supply chain. Your question, when do investments stop? At the moment, we are focusing on the internal process optimization. There are three elements of eTouch. The carrier side, the internal, and the market side, customer side. We focus at the moment on the internal part, because that will drive our productivity immediately or seamlessly. One example is AirLOG.
We invest at the moment, and we have said so in the last quarter review calls, into deploying the new operating system for air freight called AirLOG by end of this year. When the rollout is fully established, we can, with the new system in place and switching off the legacy system, by the way, we can implement the eTouch elements for our internal processes. The carrier processes in sea freight, for example, have already 80%, 90%, 95% eTouch for carriers, but it's only the carrier side. Our sea freight operating system called SeaLOG, will not be fully deployed before end of 2020. There's also a certain time lag here because we have to roll all those systems out in each and every location to 10,000 of employees. We have to train them on the new system.
We have with China exports, for example, in sea freight, only 25% of the vendors online at the moment with regards to eTouch from a vendor side. KN ESP, those platforms, the operating system, SeaLOG, they are all elements of what we call eTouch. All this plays into eTouch. What I've mentioned before, this contract logistics, also here, our growth with e-commerce fulfillment and pharma, 40% for e-commerce fulfillment and 20% for pharma, those are based on our capability of a seamless interface with our customers. Hundred thousands, millions of order lines per location per day can only be processed in what we call eTouch, in an eTouch environment. These are the investments we are currently making. When will this stop or be reduced? That was your second questions. For sure, it will continue next year.
We are in the ninth or 10th months now of deploying our Roadmap 2022, and our targets remain firm for 2022. This is what we said before. We still aim for 20%-40% eTouch shipments in the year 2022, gentlemen. We have nine or 10 months out of 60 already in our strategy. Don't expect wonders immediately. You can expect wonders, but don't expect them overnight.
Maybe on the last question, any other big buckets aside from eTouch and lower investment in the step-up from 13 to 16?
No, I think it's the overall volume growth. Our systems are capable for much stronger volume growth once we have deployed them. No other recipe that we would apply. I think we are showing with our figures a net profit improvement of CHF 40 million year-over-year for the first nine months this year, that we get traction with our strategy while we are investing and transforming the business at the same time. We are rebuilding our plane and ship and truck and warehouse, so to say, in full swing while running from one all-time high record result per quarter to the next.
All right. Thank you very much.
You're welcome.
Next question is from David Kerstens from Jefferies. Please go ahead.
Hi. Good afternoon, gentlemen. Two questions, please. First, on your yields in sea freight. Container rates were up 17%, which you seem to have fully passed through to customers. Would you say that you have been helped by the bunker surcharges that were announced by most carriers back in June? In relation to this, what is your view on the IMO 2020 surcharges that have been announced and will be implemented in January 2019? Do you expect you'll be able to offset those as well in your discussions with your customers? Secondly, regarding your air freight volumes, I think if you back out the acquisition effects, would that imply that your third quarter volume was up only 2%? Since you're highlighting exactly the same verticals as last quarter, I was wondering what is holding back that volume number?
I think 2% is roughly in line with the IATA volume numbers. Thank you very much.
Okay. David, let me answer your bunker surcharge question as well as the sulfur-induced bunker cost increases becoming effective early 2020. We have stated so at the JOC conference, these costs have to be borne by customers eventually. We prepare our customers on this already. At the moment, we see different strategies with regards to bunker cost with the different carriers. Our customers start to understand this is market and the cost structure of shipping containers with carriers is changing. Yes, we will be able to offset these costs eventually with our customers. Your question with regards to, I think, the air freight volume for quarter three. I think we have seen a slowdown in the market. Our growth was more than twice as fast as market, while we were concentrating on stabilizing yield and improving yield.
I would even say our organic growth, despite the acquisitions, have been clearly higher than market. 4%-6% would be my answer.
4%-6% organically in Q3?
Yeah.
Okay. Great. Thank you very much. Maybe can I ask one follow-up, please, regarding the comment on the weakness on Asia-Europe. Are you saying that the Chinese imports into Europe are being replaced by more imports from the United States and other markets? Or is that general weakness that you see going into Europe?
At the moment, I would not mention any structural change in markets. I think it's a general weakness. If you look into the pure import pattern of Europe from all markets, there is no decrease in imports. From that point of view, they must have been substituted by other markets. Whether this is North America or Middle East or South America, too early to say, and whether that leads to a longer-lasting structure change, too early to say. We watch this carefully. At the moment, no change in the trade patterns. No permanent change in trade patterns. It's a weakness. Nothing more.
Okay, great. Thank you very much.
Maybe I should say, Asia-Europe is weak in sea freight, but in air freight it's still growing.
Yeah. Thank you.
Next question is from Neil Glynn, Credit Suisse. Please go ahead.
Oh, good afternoon. Really just one last from me. With respect to contract logistics. Just interested, your customer dialogue with respect to pivoting supply chains away from China to the extent that you're having any at the moment. I realize this is something that can't change that quickly, but just interested in terms of your expectations and understandings of customer intentions there, and also, what proportion of your contract logistics business is actually based in China, operating for international customers.
That's, Neil, first of all, good afternoon to you. Pivoting supply chains away from China, it's an interesting question because I think the answer is twice-fold. We have a strong consumption and growth going on in China. Many of our customers producing in China concentrate more and more their production on the local Chinese market while they set up new productions or mirror production in neighboring countries, serving for exports. A trend, by the way, that is existent already for, I don't know, five, 10 years, a decade, most likely. I would say this trend is accelerating at the moment, but it's also based on the clear five-year plan of the Chinese government that has been published, I think October or so, 2016, which concentrates more and more on the local domestic Chinese market. Supply chains, because you were alluding to supply chains, are very agile.
They can react overnight. That's not a topic. The topic is more of can our customers find a tier 1, tier 2 supplier who can produce the same quantity in the desired quality in a different market? I think that's the challenge for our customers. Supply chain is not the challenge. We are very agile and adaptive.
Understood. If I can actually follow up-
The percentage of our business in China is concentrating, so to say, on international customers.
Understood. If I could just follow up with one more, actually. Sorry. In 2015, you took a bit of a new approach to sea freight. A far more selective approach given the challenges in the market at the time. It just brought to my thinking, given the outlook for 2019, given how uncertain it is. With net working capital and requirements or intensity rising with more uncertainty with respect to sea freight volume quality, is it a prospect that you may well take a far more selective approach to volume in 2019? Or should we be thinking business as usual in terms of 2018's trend continuing?
No.
You want to answer?
I think, Neil, business as usual never exists in our business because it is changing very quickly. Our strategy is clearly geared towards volume growth. Why is that clearly geared to it? Because with the new systems, with SALog coming in place over the next two and a half years, the leverage on operational efficiency will be higher the bigger the bases we work on. Volume growth clearly is our aim to achieve.
Understood. Thanks, Markus.
All right.
Next question is from Michael Foeth from Vontobel. Please go ahead.
Yes. Hi, gentlemen. Two questions, really. You were talking previously about the pricing trends in air freight underlying, and I was wondering what those pricing trends in sea freight look like. There's always a lot of mix and freight lane effects in there. It looked like GP per ton was stable sequentially, but can you talk about the underlying trends really that you're seeing? Is that under pressure? That would be the first question. The other one is, you were also talking about investments before, but I'm not sure whether you were talking about investment for the entire company. I was interested in the contract logistics specific investments that you had in Q3, and for how long we should expect those to remain high. Thank you.
Sure. Michael, first of all, good afternoon to you. For air freight, we expect stable air freight rates now, moving forward to the next couple of months. The only topic is, how do oil prices and various fuel prices develop? That's the only major variable that is difficult to assess. It will not impact the overall development from our point of view in the next couple of months. The investments that you were asking, related to contract logistics, we mentioned that a couple of times. It's investment into new generation of warehouse management systems. As I mentioned before, we see 40% volume growth in e-commerce fulfillment or in e-commerce fulfillment in contract logistics. For sure, these investments will continue in the next quarters or in 2019. We invest into picking enhancement, into new technologies to drive our picking efficiency, and also this will be ongoing.
Then, Q3, four 2019, these investments shall be completed and shall show the respective effect. The effects we are aiming for is higher productivity in the warehousing space we operate, as well as a faster capability to integrate high volume solutions in certain locations. As said, we have locations that see up to 1 million order lines per day, and our systems need to deal with these volumes. They do today, but if we continue to grow this 40%, we are preparing for future growth here.
Okay. Very good. Thank you. Just a follow-up on the first question. You were talking here about air freight. Am I correct? I was wondering about the trends in sea freight as well.
For sea freight, we see trades like Transpac continue to grow. That's our ambition, or that's what we anticipate and plan for. Some of the other trades are rather flat or with a very low growth. I think the rates, because of 2020 rates, not margins, the rates because of IMO 2020, being part of the rate structure shall go up, over the next quarters. That's our assumption. That's the way we read the market.
Okay, pricing will remain under pressure in that respect for you as well. GP per ton.
Why should that be the case? We negotiate rates with our customers, usually back to back. If this is a process that is not as agile or iterational as we have seen this two, three years ago when I was alluding to sawtooth patterns, remember? I shouldn't see any irritation in our pricing moving forward.
Okay. Thank you very much.
You're welcome.
Next question is from Andy Chu from Deutsche Bank. Please go ahead.
Thank you. Good afternoon. Just two questions from me, please. First one is on the air freight volume growth that you mentioned organically was doing 4%-6%. I just wondered, with your comment to Asia, Europe is still growing, can you put that Asia, Europe growth into context versus the group at 4%-6%? Secondly, just in terms of numbers, IFRS 16, balance sheet adjustment of CHF 1.4 billion. What is the D&A adjustment, please? Is it roughly CHF 200 million, something of that order? Thank you.
Sure. Asia, Europe, our volume growth is higher than market growth on these trades. I think that's the answer to your question, very briefly. The second question.
The second question is on the leases IFRS 16, the balance sheet impact. The CHF 1.4 billion, I would expect currently an average D&A impact of around CHF 400 million and an interest portion of around CHF 30.
Thank you very much. Just sorry, just for clarity in terms of Asia, Europe, when you say market growth, do you mean the sort of overall market, the 3% you're pointing to, is above 3%, or the growth rate on the Asia, Europe trade lane? Which I guess I don't know at this point in time. Sorry to dig a little bit more on that growth rate. Thank you.
What is your precise question, Andy? I was talking about the market growth, and we grow and our ambition is, and we are able to achieve that ambition to grow minimum twice as fast as market. At the moment, we grow double digit on these trades.
Okay. Thank you very much.
Yes. Good
Next question is from Poulain Aymeric from Kepler. Please go ahead.
Yes. Good afternoon, everybody. I've got two questions. The first is on the operating leverage side, obviously, the difficulty we have to separate what is the underlying cost inflation from what are self-inflicted investments. I understand you said that the CHF 2 per 100 kilo increase, extra cost increases you saw in air freight will not recur in Q4, could you confirm that? I think you gave a clear explanation on contract logistics, on the sea freight, I was wondering, given the investment that you're planning, what we should expect in terms of these extra costs that you alluded to. Also just to get a sense of the underlying inflation that you budget for cost in the current or the remaining of the year and 2019. That's for the first question.
Second question is, obviously, your drive for scale is very visible on the organic side, we currently see a bit more movement on the consolidation side with the DSV approach on CEVA and that could Panalpina and so forth. I'm just wondering what's your stance on this. Last year, you mentioned a reduced threat in big scale M&A, just wondered what your thought on that process at this stage.
Aymeric, good afternoon to you. Sure. Let's start with the latter question. The consolidation is ongoing, we clearly posted we have an active M&A process, more we will not disclose until we post a press announcement. We are active in the market, we always said we will not buy any potential target just for the sake of an equity story. We are looking for niche markets, for footprint, for competence in order to leverage our networks based on our strong organic growth further. We can develop positive momentum, we have shown with the takeover of CFI, Commodity Forwarders Inc. in the U.S., the perishable market leader in the U.S., a seamless integration into our networks. Or with ReTrans in the U.S., the intermodal provider that we integrated into the overland business and purchased two years ago.
You can expect other stories here, as said, we have an active process. Our belief is, yes, we talk about the big acquisitions in the market. Whether they pay off eventually, it is on you to judge, not on us. The consolidation in our market is happening from the bottom of the pyramid. The local specialist freight forwarder that serves a trade lane for certain customers in a commodity like coffee or beans or whatever. All of a sudden, through e-commerce, their customers are asking for other trade lanes, and these providers, these local forwarders are not able to serve them. Here is a very strong consolidation to notice. That is one reason why we are able to grow minimum twice as fast as market. We capture market shares, most likely from those.
We do not know them individually, our global networks become more and more compelling for small and medium-sized shippers in other parts of the world because we can offer them access to world market. Therefore, our drive for scale will continue, as Markus said, and I said before, because our operating systems are in place, our operations are scalable, and this scale we want to make best use of. Air freight, your first question or initial question, what we said is we did not give any guidance. We said a normalized or a normal cost structure per 100 kilo would be CHF 48. CHF 48, CHF 49, CHF 50. That was what we mentioned before. You saw that volume and margin effects in air freight clearly outperformed the cost effect. That is, for us, the most important message.
Likewise, we have seen this for the first time in sea freight in Q2, for sea freight, where we see that the rates are stable now, or the margins, not the rates, sorry, the margins are stable now. Also, the costs per TEU are stable, and we leverage via the volume, the overall performance of our sea freight network. I hope that answers your questions.
Yeah. More or less. Thank you.
Hopefully more than less, Aymeric.
Next question is from Bruce Chan from Stifel. Please go ahead.
Good afternoon, gentlemen. Just a couple left on my side. With regard to contract logistics, can you share with us what the cost development would have been like absent the platform investments? Then also, maybe just a point of clarification. Detlef, you mentioned that there was a decrease in year-over-year development in contract logistics EBIT for the first three quarters, and that you assume that that's ongoing for a few more quarters. Should I take that to mean that the, excuse me, the investment impact will be taking place for the next few quarters, or that the decrease in EBIT will be taking place for the next few quarters? And maybe this is a good time to ask, when you expect that EBIT margin to inflect or to begin increasing again?
The decrease will continue versus previous year for the next couple of quarters because our investments will be ongoing. Our investments in total are between CHF 10 million to CHF 20 million a year into platform ramp-up of new projects as well as the new warehouse management software. Annually, not per quarter, annually.
Great. Okay. That's very helpful. Thank you.
Sure.
Next question is from Ezra Stanford, HSBC. Please go ahead.
Good afternoon, gentlemen. Two questions here from me. Has there been any evidence of stock-building ahead of the tariffs that have already been introduced by the U.S. and China? Secondly, can you give a flavor of how you see the peak season, particularly in ocean developing this year? It was particularly difficult, as I understand it, last year with capacity issues. Can you give us a flavor of how you see it this year? Thank you.
We have not seen any evidence of stock-building yet. People are talking about it, but we haven't seen it. Therefore, that's maybe then one of the variables for the remaining months. Not yet to be seen. The peak season, from our point of view, with a slowdown in quarter three, I would say maybe it's on the same level than previous year, because at the moment, our capacity is secured. Whatever comes in, we are able to capture, and the order intake from customers at the moment doesn't show any deviation or significant deviation. Our peak season, I would say in air freight peak season, we are prepared for it, and we can even better execute than previous years because capacity is secured. For sea freight, as said before, orders are well underway, but don't expect a special season or a overheated season.
I said so also for overland before. It will be the normal heat in the remaining months, not an overheated situation, which leads to margin pressure.
Thank you.
Sure.
The next question is from Sebastian Bray, UBS. Please go ahead.
Hello, and good afternoon. Just one actually left from my side. It is with regard to the air freight side of things. You mentioned a couple of times over the course of the call that there is a slowdown. I guess that slowdown was also expressed in your reduction of your market growth there. With regard to this slowdown, is it a broad-based one, or can you pinpoint more into the direction where this is more pronounced? That would be great help.
The slowdown we have seen is Asia exports. That is Transpac related. That's the only significant deviation that we see. It's an important stream. There might be effects all over because, as you remember, a year ago, all of a sudden, the market started to spike. It's too early to predict. Yeah. Asia exports usually is an early indicator, that guides a bit our cautiousness for the overall performance of the market in Q4.
Just one follow-up. You said Asia Transpacific, right? The exports.
Yep.
Keeping with what you said earlier on, I mean, that was one of the trade lanes that was showing quite decent volumes, right? In particular with regard to Asia, Europe, for example, right?
Yes. Year to date.
Oh, got it. Many thanks.
Okay. Sure.
There are no more questions at this time.
Ladies and gentlemen, thank you very much for calling in and listening to our Q3 and first nine month 2018 review. We look forward to have you with us in the review of the full performance of the year 2018 of February next year. As said before, based on the very good results of the first nine months and our full pipeline with new customer projects, our cost control paired with the investments into leveraging our networks further, we are very confident that we will be able to close the year 2018 successfully. In the meantime, I wish you all the best and talk to you again soon. Bye-bye.
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