2023-10-18 08:58:01 ET
AB Volvo (publ) (VOLAF)
Q3 2023 Earnings Conference Call
October 18, 2023 03:00 AM ET
Company Participants
Johan Bartler - Head of IR
Jan Ytterberg - CFO
Martin Lundstedt - CEO
Conference Call Participants
Erik Golrang - SEB
Hampus Engellau - Handelsbanken
Nicolai Kempf - Deutsche Bank
Agnieszka Viela - Nordea
Klas Bergelind - Citibank
Presentation
Johan Bartler
Welcome to the Volvo Group Third Quarter Presentation. Today, we will do as always, we will listen to the presentation by Martin and Jan and we will follow by a Q&A session. we will have questions both from the line as well as from this room.
So, with that, I hand over to you, Martin.
Martin Lundstedt
Thank you, Johan. And welcome to also as new Head of Investor relations. And the special welcome to Mats Backman, our new CFO also. So, its good to see you here together with Jan and myself presenting today.
Most welcome, also from my side, to this quarter three 2023 reporting summary. Group continued to deliver strong performance in the third quarter. I'm proud and humbled to present strong growth revenues continues, increase the deliveries of trucks in turbulent times, as service business on solid levels, and the third quarter record levels for operating income, margin, and return on capital employed.
On ROCE, as a matter of fact, it was an all-time high ever than rolling 12, that is the metric. Strong outcome, of course, thanks to great work by all colleagues and business partners across the globe.
And also in this quarter, we have put priority working closely with our customers, and to stick to our priority of delivering as high volumes as possible to support our demand -- continuous demand of equipment and vehicles and continuously deliver on the solid order backlog.
Our service operations continue as I said on solid levels supporting the uptime and performance of our customers rolling fleets. And we still see transport and infrastructure activity out in the markets remain on good levels in most of our markets, but we are also gradually now coming down from a recent peak levels.
As already communicated in conjunction with the quarter two, this is highly anticipated and it means now that we are entering into a more normalized the demand situation for new vehicles and equipment on a platform as we've said of record strong profitability and high operational performance. And our first forecast for the 2024 total market is also in line with this normalized demand and we will come back to that later in this presentation.
If we then move into the highlights, Group continued to deliver strong sales growth and strong results. Sales growing to SEK132 billion in the quarter, that was plus 9% FX adjusted. Adjusted operating income growing to SEK19.1 billion corresponding to a margin down of 14.4%.
Operating cash flow was hampered partly by higher level of working capital, but everyone should remember that quarter three is always a seasonal weak quarter, obviously, coming in on down SEK5.6 billion and when we look at the year-to-date on SEK23.2 billion.
Return on capital employed, as I said, record strong of almost 34% and also earnings per share increased and up to almost SEK7 per share.
When it comes to volume development, we increased despite turbulent times, our truck delivers by 4% to 55,300 units and as I said, I mean, despite continued supply chain constraints, a little bit better than quarter two. So, I've said in quarter one, a little bit better than quarter four last year, then quarter two a little bit worse than quarter one, but now seeing better again. So, still, I mean, we are maneuvering in the in the archipelago here.
Deliveries of construction equipment declined by 21% to a little bit more than 13,000 units done, mainly driven by low deliveries in China. And for the Volvo brand, we can also see deliveries hampered in Europe by supply chain constraints and also logistics, actually, not at least the [Indiscernible] capacity that's still not is in balance, roll on, roll off capacity for complete equipment. But still, I think given the complex situation, good job down here.
Electrification, orders and deliveries continued to increase year-over-year as an increasing number of our customers are now entering into decarbonization in order to meet their mid and long-term targets. Not at least also transport buyers are more and more keen on, actually, getting hold of transport capacity. It takes time, but we see that this is a strong momentum.
And as I said already in conjunction with last quarter to reach full acceleration and full offtake, the whole electric ecosystem in the society needs to go hand-in-hand here to move from this brown platform up to the green platform, everything from grid capacity, shorting, incentives, and having visibility around that as well as we aim deliveries such as ourselves to customers, supply chains are still to mature.
And when you are building up, obviously, you will encounter, I mean, trucks in the road so to speak, but all parts of the value chain must here continue to mature and we are working hard on that.
And as one of the first out, I think this is one of the key things that we want to see also that we all together with all partners learning now how to continue to accelerate. But if you look in total, electric orders increased to 1,600 units in the quarter, a yearly pace close to 6,000 units, while electric deliveries done, for the group, increased to 1,100 units in the quarter, I should say.
When it comes to vehicle and machine sales development in value, strong sales growth for the group, a plus 9% currency adjusted. Vehicle and machine net sales above SEK100 billion in the quarter with strong growth in trucks on the back of a combination of primarily commercial conditions and also partly as I said already before, volumes. So, a very strong development here and the decline in VC then the backhaul deliveries in primarily shine as we said.
Service sales development, very important for us. We had a continued good demand for services with a strong growth, plus 10% FX adjusted. This is also the result of a number of factors, but, I mean, primarily than improved commercial conditions, but also you should remember together with the continuous high activity level amongst our customers.
And the efforts that we have done now in quite many quarters as regards contract penetration, repair and maintenance contract penetration, and other services are also of course paying off step-by-step, very important piece of the puzzle here and the Group is pacing 12 months rolling at a service level than SEK125 billion.
Volvo Buses continues to show strong service sales development as people travel are gradually coming back. They were more severely hit, as you remember, during the pandemic. Strong VFS or Volvo Financial Services growth from a growing business portfolio supported also, of course, by higher interest levels. So, all-in-all, good results of services.
When move into trucks, truck news, quite many of them this quarter again, renewal trucks to start now is following down the start of the heavy duty platform for Volvo last year. Taking orders for their renewal truck's E-Tech versions both in the T version for regional haul and regional distribution and the E-Tech C for urban construction. And these vehicles are up to 44 tons, and we'll go into serial production now in November in Bourg-en-Bresse in France.
Another milestone, a very important, Volvo Autonomous Solutions, still one of the smaller business areas, but with the great prospects, has entered a long-term collaboration with Boliden to deploy complete autonomous solutions. You can see that, on the slide here, based on the Volvo Group in-house developed virtual driver and Volvo Trucks' premium truck range.
In August, for a similar application, we also now removed the safety driver in this type of solution at the Brönnöy limestone quarry in Norway and that is of course a true milestone because now we are into -- up to autonomous operations in that quarry.
Also, Volvo Defense has entered into a seven-year framework agreement for deliveries of our Volvo FMX trucks to Estonia and Latvia Defense Forces. And the agreement also includes comprehensive spare part and maintenance programs.
Another very exciting news is that Volvo Group, Renault Group, and CMA CGM Group, you know, the big shipper, will join forces to address the growing needs of decarbonized and efficient logistics for zero-emission last-mile deliveries.
In general, last-mile delivery solutions is, as you can understand, a fast growing transport segment, linked to the long-term trend of amongst others increased ecommerce across the globe, but it's also currently seeing lots of challenges.
In addition to make these, transport zero-emission, it is also about improving work conditions such as ergonomics, stress levels, but also planning and efficiency as well as support service to guarantee uptime and quality.
The base for the corporation is an all-new generation of electric software defined vans that will be combined with completed end-to-end solutions of digital and physical services where we can leverage, so to speak, the complementary strength and not at least then the strong support networks across markets since these are truly B2B solutions obviously.
And the new core builds on the already long and successful partnership between Renault Group and the Volvo Group through our [Indiscernible] Renault trucks in the light commercial vehicle segment where we have been growing successfully over the last years and see a further good potential not at least with this new co.
When it comes to truck market forecast, maybe the most important slide, so let us -- and I assume we will see a number of questions coming from all around the globe here.
Let us start with North America then. For North America 2023 forecast to start with, unchanged at the 330,000, which is, of course, very strong levels.
And for 2024, we are forecasting a normalization, I should say, because you can see that also coming down to -- as you can see here coming down to the trend line, of around 290,000 done.
For Europe, 2023 forecast is increased by another 10,000 units up to 340,000 units, of course, also related to supply chains gradually getting better. And for 2024, we reiterate our review over normalization of the market. And also here we forecast the market of 290,000 that is also in line alone par with a long-term underlying trend line as you can see here. So, it is important, I think, to remember that the forecast for 2024 still represents good levels.
For Brazil, 2023 level is kept at 80,000. We have seen a correction there for different reasons and not at least, the change from Euro 5 to Euro 6 and I will come back to that. And we also forecast the market to remain at 80,000 for next year.
For India, we reiterate the level for 2023 and the forecast that the total market will increase to 440,000, so an increase of 40,000 units for 2024.
And for China, the forecast is somewhat increased already for this year and a further small increase done still on rather low levels for next year up to 700,000.
When it comes to truck orders and deliveries, we continue -- even if, I mean, it's a little bit changed pattern to be somewhat restricted by gradually opening the order books in different regions, depends a little bit where we are. But still, I mean, super important to manage the cost inflation pressures and cost balance overall, but also to strictly manage inventory levels in the entire value chain, as we continue to see, as I said, the anticipated signs of markets in Europe and also somewhat in North America that are normalizing.
All-in-all, we had a book to bill in the quarter that was 0.85% [ph] and -- also in line with the year, 0.86%, I think it is for the year in total. But also remembering that we have been entering this year with very high order backlog.
We will, of course, in that regard, continue now to make sure that we have the right balance between order intake and production inventory and deliveries. So, we have an order book with the right quality to manage delivery reliability and the need of continuous volumes, while the same time, manage inflation, as I said, and also other uncertainties. We continue to keep a high level of flexibility to manage any mid-term changes in demand and have ability and flexibility.
Truck market shares when it comes to market shares, starting with North America, Volvo and Mack have been affected by specific supply chain constraints over the year and reported that already in quarter two. And now we have a combined market share of 15% year-to-date.
When it comes to market shares in Europe, Volvo and Renault in combination are on a good level of 26%, somewhat decreased. We had a very strong development last year, as you remember, because we had the good ability to deliver, but still 26% is really good for us and also market share on battery electric up to 68% than in Europe.
Volvo's performance in Brazil also very strong, almost 24%. Historically strong. We had a weaker start this year because we didn't have a lot of Euro 5 trucks in the pipeline. We deliberately took that decision and therefore market shares were hampered in the beginning, but now we are catching up and we still -- we see a strong market share position Euro 6, almost 30% actually.
And also Australia, I have to comment an important market for us. Volvo and Mack in Australia performed well and 26% combined that is also historically high.
Construction Equipment, we continue to rule out also the electric executions in VCE. Not at least in the very important, I mean, 20-ton plus segments, 23-ton electric excavator. We have been rolling that out first in Norway, but now we are continuing in key markets such UK, France, Sweden, The Netherlands, to mention a few.
And also along with the EC230 VCE is now also offering a more comprehensive solution with a new power unit, as you can see here, and -- that is a power unit, or a power bank with the 400 kilowatt-hours and brings power to sites with the week or no local grid and can also serve of course as a smart grid, smart local grid cost arbitrage by charging when commercial conditions are favorable along the week. I think all of you are familiar how that works and the opportunities around that.
Market forecast for Construction Equipment, when it comes to -- there is a continued growth in North America, while the European market is expected to be flat in 2023. China continues to contract. So, it's very much in line with what you have -- what we have said, and for 2023, we're not changing any of the market forecast in relation to what we already reported in quarter two.
When it comes to 2024, our first guidance then, in Europe, we say minus 10% as a midpoint in our guidance range. And in North America, minus 5% as midpoint, so up 5% this year, down 5%, but still on solid levels and also for Europe, obviously.
And South America plus 5%. Asia, excluding China, minus 10% and a somewhat further contraction in China as well than minus 5%.
Book to build and orders here continue good demand, as we said, in North America, supported by infrastructure projects, while demand in Europe soft done somewhat then, and in accordance with our guidance on the back of higher interest rates, weakened macroeconomic outlook, as you know, building segment, outlook weaker, et cetera.
But, an overall order line of 27%, mainly driven by China as well as cautiousness among customers and dealers in Europe. So, it's, of course, I mean, a little bit of an overreaction we see here now in order to balance, so to speak, also the pipelines.
Elevated order numbers in North America, as the dealers now are allowed to place orders for first semester next year, as well as very weak comparison with the last year's similar quarter.
And that again now is really how we open and manage so to speak the order board. So, the very strong order intake comparison there plus 196% is also that should take, I mean, a little bit, wider look on that.
And I think in this situation, the overall market guidance is maybe more important than the order intake per se quarter-by-quarter both for trucks and construction equipment. Deliveries declined with 21% as I've already said, the mainly related to China and somewhat the supply chain and logistic to services for Europe.
Buses, orders increased, by 6%. So, it continues, mainly driven by improved demand for coaches and electric city buses and deliveries increased 4%, mainly driven by a higher volumes of coaches in North America than both Canada, US, and Mexico.
Book to bill in quarter three was 112% or 1.12. And during the quarter, an agreement was signed with you can European body builder MCV. We are already having a very successful cooperation with them for the UK markets, but now also for the Volvo 7900 Normal and Arctic versions as well as electric body also for intercity traffic, supporting the new business model and the turnaround for our European business that we announced in quarter one. So, it's a very important piece of that puzzle.
And Volvo Buses also continues to their electric sales momentum in UK with electric bus orders in this case from two operators. And they are based on the same global, BZL electric chassis. So, in that sense, I mean, good quality and momentum for buses.
Volvo Penta, orders decreased by 28%. Similarly, you can say demand coming down across segments Marine Pleasure, Marine Leisure segment, below 40 feet primarily. Also Industrial segment, similar pattern as we see in Construction Equipment and Trucks, but partly offset by continuous strong demand and strong demand in the Marine Commercial segment and that is of course related also to, for example, the built out of wind -- offshore wind farms.
Deliveries decreased by 9% in the quarter on the back of continuous supply chain disturbances. We are still struggling here and we have a high order board that we need to continue to execute upon.
Volvo Penta is also currently forcing and focusing its sales and service network in the growing industrial segment. We have as you know, over the last five, six, seven years, been very successful in actually growing the industrial part of Volvo Penta. And now we are focusing also more and more into specific, industrial service network.
And, as one example now during the quarter, we have appointed Swecon, the current VCE dealer for Sweden for the services and sales into that segments. So, that is also coming along immediately for our customers to have complete solutions obviously, both here and but also for future, renewable, propulsion systems.
Finally, VFS, record business volumes for the third quarter. Volume was SEK29 billion in comparison to SEK25 billion last -- or the same quarter last year. And net -- we see the net credit portfolio growing to SEK255 billion and portfolio performance continues to be good since our customer's financial health is overall good and with good payment discipline.
So, by that, that ends the first business update. So, Jan, I leave it to you for the financial update.
Jan Ytterberg
Thank you, Martin. After the last two quarters, I have frequently got the question from you, is this the peak of the cycle? And, if this seasonally weak third quarter, where we have low deliveries with an adjusted operating income of SEK19.1 billion and a margin of 14.4%. If that was the peak of the cycle, then I'm fine.
Similarities from the last quarters can be seen also here in the third quarter, as price realization continued to be good, mitigating then the cost pressure from salaries, inflation, and also from the transformation. And we continue to have supply chain disturbances, but sequentially lower and also compared to the third quarter last year lower.
If we move over then to the income statement and the topline, the increase of net sales was 15%, but of course, positively impacted by FX, as the Swedish krona was weak against all important currencies for Volvo. If we take away FX, it's 9% over [ph] increase, and that is mainly related to price, partly offset then by the lower deliveries in Construction Equipment.
As you can see, the increase was substantial in Europe and North America, whereas the low demand level can be seen in South America then and in Asia, of course, hampered by the low, construction deliveries -- Construction Equipment deliveries, but partly mitigated by other business areas that had more increases of deliveries in Asia.
Moving over to the earnings as such then, despite the volume that was on par or actually a little lower in the different business areas compared to the third quarter last year, we delivered an impressive financial leverage FX excluded of over 50% in the quarter.
So, as I said, SEK19.1 billion of adjusted operating income and 14.4% and similar to last quarters, we are maneuvering in an environment of inflation and transformation by adjusting our commercial conditions to mitigate these cost pressures then.
And we continue to be successful with price execution, both for vehicles and services also here in the third quarter, and that contributed positively to the improvement. And on the negative side, we have the higher per unit cost, in our own production as volumes are stable or decreasing. And at the same time, we, of course, feel the pressure from the general inflation and the salary increases.
On the positive side, we see freight costs coming down, slightly, both as effect of, less of rush transports, but also that the freight tariffs are going down. The general inflation and salary increases are of course impacting all operating expenses, besides this the ambition we have to be in the forefront of the transformation with electrified autonomous vehicles, but also on the combustion engine side that, of course, needs more resources, more activities, and thereby higher cost, and that is seen in the selling expenses and R&D costs. And we had actually, a positive net capitalization effect of SEK0.4 billion in the third quarter, we expect similar positive net capitalization also in the fourth quarter.
As you can see on the slide, nothing about sort of material costs, which has been sort of something we have talked about a lot the last quarters, but the fact is that we are on similar level as the third quarter last year where we have positive effects coming from raw material offsetting the negative effects as we are -- on the material cost, as we are compensating our suppliers for their inflation and their salary increases.
We've gotten positive FX effect of SEK1.2 billion in the quarter then, where a limited part of that was the transaction exposure and for the fourth quarter, we expect transaction exposure to be neutral, and we do not give any full guidance of FX effect for the fourth quarter.
During this quarter, we also then divested our entities in Russia that had been put on hold since the Ukraine war started and that gave a loss of close to SEK800 million in the quarter, and that has been classified as a significant item affecting comparability and thereby excluded from the adjusted operating income and you can find that effect in Group Trucks and in Financial Services.
As Martin, we're into cash flow, third quarter is a seasonally weak cash flow quarter, when productions are low and we are paying down the trade payables. That in combination with the high volume we have, supply chain disturbances, but also the fact that we are gradually ramping up our better electrical value chain that put mark in our, operating cash flow as inventory continued to increase here in the third quarter.
All-in-all, operating cash flow in an industrial operation, SEK5.6 billion, and of course, as Martin was into, the focus now is, of course, to take down the inventory, both at our own factors, but also, and you can say, the second production line we have at the body builders, so that we can adjust the inventory level to the lower future demand.
Then the positive operating cash flow was also the reason why we had an increase of, the financial positions to SEK65 billion at the end of the quarter and return on capital employed as was mentioned, 34% on a rolling 12-month basis for industrial operation, and that is, of course, reflecting the strong earnings the last quarters.
Then we move into the different business areas then, and start with, Group Trucks, where we have an increase FX adjusted net sales for Group Trucks of 13%, price execution, and of course also the 4% increase of deliveries are impacting here.
And price realization was the main explanation behind the increase of results in Group Trucks, an improvement of SEK6.7 billion in the quarter to SEK14 billion giving an adjusted operating margin of 15.6%. That must be considered very strong for the third quarter.
Similar to the group, the headwinds came from the higher unit cost in production, as salary increases and general inflation impacted negatively, partly then, as I said, compensated by lower freight costs.
Supply chain disturbances continued, but were at a lower level than the third quarter last year. And the general inflation and salary increases are impacting also, of course, on operating expenses and that in combination with the high ambitions and activities we have around the transformation impacted negatively on selling and R&D expenses and we had a positive FX effect of SEK0.9 billion for Group Trucks.
Moving over to CE, we have talked about it before, total deliveries continue to decrease in Construction Equipment, mainly related then to China. We have an FX adjusted net sale decrease of some 4%. Of course, the lower deliveries, but then partly, compensated by higher prices in general and also, the improved mix we have of brand and markets as we are selling more of, Volvo heavier machines in North America and in Europe where the commercial conditions are better and less -- comparatively less than Chinese machines that way we have a very tough price, competitive environment.
And of course, that is impacting our SDLG brand quite substantially. The positive price and the mix effect impacted adjusted operating income positively, but not fully compensated for the lower deliveries than impacting both as less gross income, but also difficulties to handle sort of the absorption of fixed cost out in the production.
Also here, the general inflation salary increases are putting marks in our operating expenses. We then -- on top of that high activities on the sales side in Construction Equipment, we got the negative effect on the selling expenses, more or less flat adjusted operating income of SEK3.7 billion, giving a margin of 15.4% and a small positive effect on currency in the quarter.
For Buses, we continue to see an improved environment -- business environment, The high activity level was seen in our service side -- in the service revenues, and this together with the general price increases impacted positively on FX adjusted net sales, up 6% and, of course, on the earnings.
Despite the supply chain disturbances that we had on buses, production efficiency improved, contributing then positively to the increased adjusted operating income. The increase was 200 -- more or less SEK240 million, up to SEK340 million and the margin of 6.3% for buses. We have a little more pressure from the material costs, but we also had a positive FX effect of some close to SEK100 million.
And also Penta experienced supply chain disturbances and that impacted engine volume and impacted the production efficiency negatively. Higher prices and a favorable mix with more of heavier machines, heavier engines impacted both net sales and the earnings positively. Whereas then the cost pressure from material and the high activity on the sales side impacted negatively, besides the already mentioned production efficiency.
Net sales up 5% for, Penta. FX adjusted and adjusted operating income of SEK790 million and a net margin -- adjusted margin of 15.9% in the quarter. And also we have a positive effect of FX of -- or in this case, slightly over SEK100 million in the quarter.
Then we move over to Financial Services and as I said earlier quarters, the numbers in this slide has been then restated to exclude the Russian and the Belarus operations in all the quarters. Similar to earlier quarter, this year we see then that the high deliveries and improved prices are, of course, impacting positively on the portfolio growth.
For Financial Services, new business volume increased 13% FX adjusted in the quarter, and we, as Martin said, ended the quarter with SEK255 billion of credit portfolio.
The fierce competition from banks and leasing companies continues and is putting press on the earnings, but also on our penetration that were really the lower on the rolling 12 months basis than last year, 27%.
And also as mentioned, customers' financials and payment performance are good and that's also why we have low write-off levels and low credit expense levels. And the improvement of adjusted operating income of 1 -- up to SEK1.062 billion was then mainly related to the portfolio, partly then offset by the spread compression, and we also had a small positive effect from FX in Financial Services.
So, before I let Martin summarize the quarter, I would like to do a little summary by myself, actually. I am now handing over the CFO role to Mats as you heard. And the figure I have in front of me is SEK280 billion, 0.8 operating income during 63 quarterly presentation that I've done as a CFO for listed company, whereof SEK190 billion have been during my four years at Volvo.
As they were saying my hoods [ph], respect. And now, I would like to thank you, of course, for a very good cooperation and good luck to you with everything going forward here.
And now, Martin, it's up to you to summarize the third quarter.
Martin Lundstedt
Thank you, Jan. And then did see that we became a little bit emotional there. That's good. We need that more in finance as well. No, no, but a great deal and, we will continue to work together, obviously. But if we come back down to this quarter, for the Volvo Group.
So, in summary, I would be short here, but despite extremely then challenging and complex, global conditions as you all aware of, proud and humble to present another strong quarter for the group on behalf of all dedicated and passionate colleagues in the Volvo Group.
We continue, as I said in the introduction, to work closely with our customers and to stick to the priority of continuing to deliver and to execute on the order backlog, even with extra cost that comes along -- that we have seen also in this quarter.
At the same time, we are focusing on the right balance between orders, production volumes, inventory level, and deliveries by having a high degree of flexibility. And we see that transport and infrastructure activities continue at good levels in many of our markets, but also that we are now gradually entering into a more normalized demand situation, and that is reflected in our total market forecast for 2024.
With high operational performance and profitability, resulting in a strong financial position, we also continue to prioritize innovation investments to stay in the forefront of the transformation of our industries and markets.
The importance of performing today to be able to transform for tomorrow has never been more important and will be decisive for the years to come and this ability to both perform and transform should benefit our customers, colleagues, shareholders, and also hope for the society as a whole.
So, by that, Johan, I leave the word to you to lead the Q&A session.
Question-and-Answer Session
A - Johan Bartler
Thank you very much, Martin. Very good. Thank you. Yes, thank you for that, Martin. We will start with the Q&A session, and we'll start here in the room, and then we take some on the line. Erik, please go ahead and limit yourself to two questions, please.
Erik Golrang
Two questions. Okay. Thank you. Then I'll ask -- okay, the first one on preparing. Let's say that those 2024 end market assumptions are correct, and you perform about in line with the market and volumes down then somewhere around 10% or maybe a bit more. How are you preparing for that in terms staffing and costs and so on? And what kind of profitability contraction alone from that volume drop?
And then the second question, would have to be on electrification then and the future, as you said, we're getting some of the statistics now from the efficiency and performance of a well-known US, I guess, in truck term startup, and it looks pretty impressive.
And it brings mind whether or not you're about to change the thinking of maybe doing a truck from -- an electric truck from scratch, given the aerodynamic benefits that that could come with?
Martin Lundstedt
Thank you, Eric, for those questions. First and foremost, as you said, I mean, if we start with 15% so to speak correction here, obviously, I mean, we have the flexibility system to handle that, and we should not forget about the fact also that we have had a situation now where we have really pushed the system really hard, with also utilizing the flexibility tools that we have both as regard bank or time banks, that all pretty -- fill up now if I put it like that.
And the second piece is obvious also temporary contracts and other flexibility measures. So, there, I think we are well prepared for that. I think more importantly, it's very -- it's to be close now, to the balance, as I said, between, production, deliveries, inventory, pipeline management, also including body builders. So, you don't have a double swing, so to speak, and you start to adjust accordingly.
And also to -- I mean, keep, the commercial discipline, because, we are in front of important investment that we should continue to pursue and therefore also the commercial discipline, I think, is very important.
And then you can say that not only that we've had these extra push, but that has come also with -- you can say a price on the operational efficiency and operational leverage because as you can see in this quarter, we didn't see anything of that basically. So, there is also room for continuous improvement.
And at one point in time, you need to reset the system a little bit because even if we have been able to increase volumes, et cetera, it is still coming to, I mean, a lot of, German fix so to speak. So, I think we're well-prepared.
Then of course when it comes to what is happening now in the transformation, we will see a lot of different type of comparisons. And first and foremost, you can state that it goes always that we have, the highest respect and -- I mean -- and you should always be on your toes when it comes to competition, both new, competition, new geographical competition, but also existing competition. So, that is number one, but also that we have high confidence in our own ability to manage this transformation. We have been early out, we have learned a lot and we see you also now how different comparisons are coming out and that we are following very closely.
But of course also some of the comparisons are contained if I may say so a little bit of [Indiscernible] type of parameters because, if you take the comparison between passenger cars and trucks, obviously, you have specialized the vehicles for different applications.
So, in that regard, it is very important also to see, okay, how is the full constitution of that solution looking when it comes to range, when it comes to gross combination, weight, when it comes to efficiency, when it comes to the weight load, loading factors, et cetera, charging times, uptime in the general service network, what have you?
Then when it comes to the BEV, native type of discussion, I think that's relevant and we are, of course, working in our modular concept of that. And then when it comes to the aerodynamics, it's a little bit what it is, when it comes to the North American execution of trucks given what you have in rules between tractor and trailer and the European. Now, Europe is gradually opening up for that with extended front door, which I think is good for several reasons because, aerodynamics will play a very important role.
Having said that, I mean, you will have now, as always, a little bit -- it's a forced moving material, and you will have a little bit of, I mean, quicker iterations, forced so to speak generation race also when it comes to some of the specific parameters. So, the race is on. And, we will participate in that race, but the full respect for what we see in the marketplace.
Johan Bartler
Very good. Thank you for that, Erik. We're moving over to the telephone line, and the next one is from Daniela Costa at Goldman Sachs. Please go ahead, Daniela.
Unidentified Analyst
Good morning, all. [Indiscernible] here from Goldman Sachs on behalf of Daniela Costa. Thank you for taking my question. I've got three, and we can take them in turn. So, first of all, could you please provide some more color, the expected impact in 4Q from the UAW strike?
Martin Lundstedt
Yes. I mean. Just to give a very short update on that, we are in a situation where we are renewing, so to speak, the contract for primarily Mack trucks down. That is what we call the overarching contract called Mack Monster.
And we have had the good with the unions over the -- during the course of this year because it's a very comprehensive contract always. And actually we put forward a proposal that we had a joint agreement around that contract.
And then it works like that that it's voted amongst members, and it was voted down. And after that, so to speak, we had this strike starting, since a little bit more than one week now.
We're working on it. Let's see. So, we cannot judge that for the time being, the most important is to find a solution that is acceptable for the parties. And for us, it is very important that this solution that is acceptable knowing the fact that we are the only truck OEM in the North America that is producing 100% of our trucks in United States, where of competition is producing either big share or a very big share in Mexico.
So, of course, for us, it's important that we can continue to have a competitive situation, but at the same time, making sure that our colleagues also have a have a good condition. So, we will follow that, but there is where we are now. So, to give any focus, I cannot do that.
Johan Bartler
Very well. Thank you for that. We're moving over to the next question here in the room from Hampus. Please go ahead.
Hampus Engellau
Hampus Engellau, Handelsbanken. Two questions from me then. Firstly, on the order -- on the organic growth in service of 10%, could you maybe elaborate a bit on the pricing there, is there an underlying volume growth? Then a more technical question is, are -- what we're looking at running diesel engine on hydrogen? And if so, is that within the cell-centric collaboration, or is it standalone? And will there be a third drivetrain going forward for being more CO2 clean, I guess? Thanks.
Martin Lundstedt
Thank you, Hampus. On Services, I don't know if you would like to elaborate on that?
Jan Ytterberg
No. I mean, of course, prices is -- has been big portal of behind the increase of FX and FX adjusted sales increases on services. With that said, we are on a high level. We are sort of, having more and more of contracts, which means that are securing future revenues in -- for the Service side.
But if you take a look on the total, prices is bigger, much bigger than volume. So, there are -- we have around 2% to 4% on volume, but it's not much more of that. That is sort of normal situation.
Martin Lundstedt
Yes. And I think there is more about the long-term trend. As you said, I mean, as I say, Jan, I mean, constantly contract penetration and since that is gradually kicking in, I mean, of the warranty periods, et cetera, I think that has been a super important but then quarter-over-quarter obviously, I mean, it's kicking in step-by-step. And here we have seen a good price reallocation. But we are in good levels and we talked about it also 2008, 2009, the Big Recession, you remember that. Then we had -- I mean, falling off the cliff when it comes to new equipment as some of us remember then we were down what was it 7.5%.
Jan Ytterberg
7.5%.
Martin Lundstedt
Services. And then we had a lower contract, but generally speaking in the industry. Then when it comes to the renewable powertrains, if I put like that, we have communicated, three parallel tracks, in order to cover the global demand and global application demand, and it's battery-electric than obviously, it is fuel cell electric. So, you have the same, basically, powertrain, but you have different energy sources on board, and that is the cell-centric operation with a fuel cell stack.
And then the third is combustion engines with renewable fuels where of hydrogen is one of those in the long-term, given also, different type of applications. That is not part of the perimeter of the cell-centric because that is the fuel cell stack development and production and commercialization together with Daimler.
But on the hydrogen combustion, our announced acquisition of 45% or -- I mean, it's an MOU so far, of the heavy duty Westport Fuel Systems is in line with that since that technology corporation is based on, you can say renewable technology already today for liquefied biogas where we have a strong position and further on than for hydrogen.
And the construct of that is obviously that we would like to see how the pace coming in also soon. So, we can get a good standard in the market on that side as well because it will not be one silver bullet to be clear here. This is a little bit like the world or silos. So, we're talking about construction industry, so cement industry, so steel industry, so trucking industry, so shipping industries, and everyone is looking at from the center of the world.
Reality is that we need to look at the world as such and see, okay, how does the energy mix look like four different sectors, different geographies and here I think we have a very, very strong platform of addressing, the need based on different technologies.
Johan Bartler
Very well. Thank you for that. Returning to the telephone line. The next one is coming from Nicolai Kempf at Deutsche Bank. Please go ahead.
Nicolai Kempf
Yes. Thank you, Johan. Good morning. It's Nicolai speaking from Deutsche Bank. And to put one more emotion, I think this has been a very strong result, so well done. Two questions from my side. First one is on lead-times. You still mentioned that you're a bit more restrictive on the order intake. Can you update very currently on lead-times?
And my second one is on product cost because you did mention that product cost has been issue in the third quarter as well. If you think about a truck for next year, we see higher cost from labor side, but probably lower input cost from steel. Equals sometimes fall up, would expect that price cost for a trucker come, up next year or down? Thanks.
Martin Lundstedt
Yeah. Thank you. Thank you, Nicolai for that. Lead-times, as we said, a little bit depending on regions and how far out we are. If we look, generally speaking, we all, we all fill up for this year, and then we have a good filling rate for quarter one, and we are continuously gradually filling, that in certain cases, we're also, so to speak, fill up for quarter one. So, that it differs a little bit.
Then depending on the pattern of different regions that is what we mean with still restrictive, because we don't want to push fixed orders too far out in time still. And what it's about now is to really manage to onboard also in a smart way together with, both upstream and downstream, working capital and inventory levels, et cetera.
So, not that, I mean, a normal balance when it comes to lead-times, but getting there also when you see when it -- when it comes to book to bill, et cetera, and it will gradually continue to adjust as we have guided for when it comes to the total market. Jan, when it comes to product cost, I don't know if you would like to start as we mix the voices a little bit.
Jan Ytterberg
Production cost, I mean, we will see the similar things that we saw here in the third quarter also in 2024. I mean, the salary increases are there. They are pretty -- it will be pretty high, most likely, in historical perspective. And with where we are coming into now to sort of more normalized level means also that we can train our production system.
We, from time-to-time, call our way of running the company has been at least related to production, whatever it takes, meaning that we have really, really focused on delivery for to the customer and on the customer promise, meaning that we have absorbed extra cost.
And, of course, now we are coming in a situation where we can take those costs out gradually, which is, of course, good for -- for the per unit cost. And then, so let's see, how that will pay out. As I said, it will be difficult to be in a decreasing, volume market to take out sort of the salary increases by efficiency that -- that will be to some extent, but, fully, it's difficult.
On the material cost side and the raw materials, let's see. I mean, it's too early to make any prediction for 2024. But, I mean, what we have seen now is, of course, very, very good on the material side that we are getting a positive effect from the raw materials. But, our suppliers, they have also to battle with the salary increases, the general inflation, et cetera. And similar to what we saw in this quarter, we will surely have to compensate for -- for that also to our suppliers. Yeah.
Martin Lundstedt
But, yes, to add on that, I think, because that is often up also as a as a discussion point, and, obviously, we have a very, professional methodology, how do we actually work with that together with our supply chain partners? Because in this -- in this situation, it's super important that you're looking into the different element of the commercial, so to speak, the commercial transaction, because it differs, a lot, when it comes to the raw material content, the regional type of content, and then, obviously, the production, added -- production value add and also that we gradually, so to speak, improving our products also. That is upgrading value for us and thereby also our suppliers. But there I should say that we have, in my book, a very professional way of dealing with that also.
Jan Ytterberg
But coming back to I mean, what you talked about before, the persistence on price. It will be very important, of course, coming into 2024 that we will be sort of what we call last man standing on the price side.
Johan Bartler
Very well. Thank you for that.
Martin Lundstedt
Good value for money as we saw.
Johan Bartler
Thank you, guys. Agnieszka, next question, please.
Agnieszka Viela
Yes. Agnieszka Viela, Nordea. Maybe follow-up on price realization. I mean, you have been very successful with, pricing so far so can you comment on your expectations for 2024 when we will see the markets cooling off? Do you expect pricing discipline, industries -- at large as well?
Martin Lundstedt
Do you would you like to start?
Jan Ytterberg
No. And, we are debating this a lot, of course. And maybe it's strange, but I'm more maybe on the positive side, because I believe with the situation we are in, we have the inflation. We have the salary increases. We have the transformation. We as an industry cannot permit ourselves to decrease prices. This is our funding from the, combustion engine side that we need to have. So that's one parameter.
And the other parameter is also that there are no more, capacity being added into the combustion engine side. On the contrary, every day, some capacity is being lost, because things are not renewed, not newly invested, more capacity added, et cetera. So I think there will be resilience, on price side when we come into 2024.
And we should also remember it's not sort of falling off the cliff situation. It's a normalization of the market. So I'm pretty optimistic actually that we can be able to manage and handle the price, make hikes as we have done in 2023. That will be difficult in 2024. On the other side, we see lower costs as well, in many areas.
Martin Lundstedt
But I think also, I mean, for us, at least, it's clear that, I mean, the hunt for the extra volume in relation to the risk for the company in terms of, I mean, the balance between our commercial, downstream conditions and upstream conditions are extremely important because, I mean, it has been a long, I mean, scale, is often, I mean, if you don't manage that, in the right way and volumes and the harmful the wrong type of volumes.
In the market that we've had now, it has been a handful of the right type of because our customers are desperately needed that. Now it's about really maintaining good quality in the business in order to -- to make sure that we can fund the transformation, and still be an attractive case for our shareholders. I mean, that balance is what is most important for us now. So fully agree to what you said.
Agnieszka Viela
Perfect. Thank you. And then one more for me. On the market shares, I mean, they have been coming down in some markets, and, obviously, there is some volatility on a quarterly basis, and you're against, quite tough come from last year, but don't you think that you being restrictive in taking orders is a reflection of somewhat lower market shares?
Martin Lundstedt
The market shares for us. I should not say that because eventually I mean, so far, it has been, maybe it could be one market or two et cetera, because at the end of the day, when you have a supply restricted market, you're coming almost into an I mean, it sounds not good to what I was saying about the community to a little bit of an allocation game and depending on how we all, so to speak, trying to allocate, our volumes in relation to competition because it's a true competition out there. And, I mean, it's a well-functioning market in that sense. Very, very fierce competition, obviously, in certain pockets, you can probably see that.
But generally speaking, what has happened what it is -- what it is a little bit what I said because we are running the machine as much as we can in terms of output, then it's clear that we have had specific related supply chain issues in North America during the that has been more related to us than to the industry in general, which is a pity because, we have a very, for the time not for the time being, I think we have built up a very, very strong position amongst our customers. We have a great product and solution offering.
So that we of course, addressing that now together with our supply chain partners. But, that I should argue is where we have been relatively, to speak, losing out Europe, 26 combined, historically very strong for us. Australia, very strong, Latin America. Generally speaking, Peru, that is I mean, we cannot talk about all markets here, but take Peru. That is a big market for us in terms of revenues, right? We are at 30%. We've never been that high. And so, yes, supply, supply.
Johan Bartler
Very well. Thank you for that. We turn to the telephone line. The next one is Klas Bergelind at Citibank. Please go ahead, Klas.
Klas Bergelind
Thank you. Hi, Martin and, Jan, the seventh club at 52, the first one I have is on the gross margin next year given how you guide. I think 70% of the cost is variable risk, 30% of the -- basically the fixed cost. So and you should be able to take that out three to six months.
So, it looks like we should be able to handle this volume decline you're talking about quite well. I'm not asking, of course, about a number here, but unless pricing goes below post. Then I think we should have a quite normal drop through at around 20%. The comment here on the flexibility would be would be great. Thanks.
Jan Ytterberg
No. And as Martin were into, we haven't embedded flexibility, of course, in our production system, and we will have to use that. With that said, it has to be similar to what we have done. Now we have to fulfill the customer promise and gradually take out costs, and the extra cost we have discussed. And 290,000 in Europe and North America that is not a bad market at all. We should make good money in that market.
So, I mean, we are not so we I mean, we will have to handle that, and, we are coming from a very high level. We should remember that as well. So it's easy for me to say I'm not so concerned.
Martin Lundstedt
Thank you. No. No. No. But, I mean, and Jan, what I think is maybe the most important is to be active. I mean, right now also to read the right signals, Klas, you always know, I mean, what do we see in terms of Agnieszka said also in terms of demand signals, inventory levels downstream, had us look at the bodybuilders. Reminds me a little bit of my mother always getting asked when she was in school with the younger teachers and they asked, I mean, now I have my new baby, how much should I dress that baby when it's winter time?
And then he said dress it as you think it should be dressed and then you take off 50% of the clothes. And it's a little bit the same here now that I mean when you get in signals be realistic about the demand signals and act accordingly because I think in that mitigation period it is important to really not end up with unnecessary inventory for example because that gives a lot of wrong type of focus in an organization but really to make sure that you have handled that in a smart way and then work with the flexibility that is embedded.
Jan Ytterberg
And of course with the high service business we have of course that is a very nice cushion we would go into what we have seen in the past.
Klas Bergelind
Yes, very quick final one on North America. You're obviously catching up here on orders again versus the market. You were underperforming before as you hadn't opened the order book, but now we have the strike coming. I'm sure you think about this not impacting sort of the total system in North America. You're catching up now in terms of water intake, but thinking about the interior and the potential impact?
Martin Lundstedt
Now, I mean, as we said, it depends a little bit on how the situation will develop here. But I think it's extremely important to have a mid to long-term view on this. We have been building up strong resilience in North America, necessary resilience in North America after many, many years and decades of low negative or even mediocre performance and therefore to continue to build that strong business at the same time as we have a fair development here is the number one priority as we speak now. But let's see how it will develop. But we are seeing it very positively when it comes to the future development here. We are investing in North America, but let's see how this specific event will develop.
Klas Bergelind
Thank you.
Johan Bartler
Thank you that, Klas and thank you, Martin and Jan. That concludes the Q&A session. All presentation material today will be found on the Volvo Group homepage. And thank you for coming, and thank you for calling in. See you next time.
Martin Lundstedt
Thanks.
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AB Volvo (publ) (VOLAF) Q3 2023 Earnings Call Transcript