AB Volvo (publ) (VOLAF) Q2 2023 Earnings Call Transcript

AB Volvo (publ) (OTCPK:VOLAF) Q2 2023 Earnings Call Transcript July 19, 2023 3:00 AM ET

Company Participants

Johan Bartler - Head of IR

Jan Ytterberg - CFO

Martin Lundstedt - CEO

Conference Call Participants

Klas Bergelind - Citigroup

Jose Asumendi - JPMorgan

Erik Golrang - SEB

Daniela Costa - Goldman Sachs

Agnieszka Vilela - Nordea

Olof Cederholm - ABG

Jan Ytterberg

Warm welcome to the Interim Report Presentation for the Second Quarter. We will start in a little unorthodox way. It's not every decade we actually present a new Head of Investor Relations, but we are doing that today. So please Johan Bartler, our new Head of IR, welcome. Johan has an immense experience from the Volvo Group over 25 years, where over the last five years at Investor Relations. So, of course, we are happy that you're taking on the challenge.

Johan, welcome. And the floor is yours.

Johan Bartler

Thank you, Jan. And thank you for the privilege. So, welcome to the Volvo Group second quarter press conference. We will do as always, we will start with the presentations by Martin and Jan, followed by a Q&A session.

So with that I hand over to you, Martin.

Martin Lundstedt

So, thank you, Johan, and most welcome to your new position, not welcome to the Volvo Group, but to your new position as Head of Investor Relations. We are looking forward to work closely together as we have done before. And to all of you also out there welcome also from my side to this quarter two, 2023 reporting.

The Group delivered very strong performance in the quarter, and I'm both proud and humbled to present the strongest quarterly earnings ever on behalf of all colleagues in the Volvo Group. The hard and dedicated work from all colleagues and business partners is really shining through in this quarter. But having said that, there is still more potential to work on and to release, and that is, of course, also encouraging moving forward. We continue to stick to our priority of delivering as high volumes as possible to support our customer's high demand of equipment and to execute the good order books.

Our service operations are also developing well, supporting the customers' installed fleet. We continue to see transport and infrastructure activity remaining high on good levels in most of our markets, but we will also gradually move from recent highs for natural reasons that we will touch more in detail later on. And it means that we step-wise are entering into a more normalized demand situation. But we are doing so on a platform of record strong profitability and high operational performance.

And to have continued strong and sustainable earnings, it's decisive to fund our leading position also in the ongoing transformation of our industry. This is a transformation that has started, but must now accelerate to reduce the climate impact, while at the same time improve safety and productivity. The Volvo Group is having a very strong position in this transformation, and it will continue to require substantial investments and competence shift, but will be to the benefit of our customers, shareholders, society at large, and for the competitive position of the Volvo Group.

And when it comes to the quarterly highlights, the Group continued to deliver strong results in quarter two with sales growing to SEK141 billion, plus 11% adjusted for currency, that was an all-time high. Our adjusted operating income grew to SEK21.7 billion, corresponding to a margin of 15.4% also that an all-time high. And we generated a relatively strong cash flow of SEK12.6 billion in the quarter, even there are more to do in different parts of the value chain, and in particular, working capital with the volume increases and also disturbances.

Return on capital employed amounted to 30.2% in Industrial Operations and the earnings per share increased to SEK5.3. So all in all, very strong results. Thanks to great work by all colleagues and supported by improved commercial conditions, despite continuous supply disturbances and inflation headwinds.

When it comes to volume development, we had all-time high truck volumes in the quarter. The deliveries amounted to around 63,800, and the increase was entirely driven by increases of light commercial vehicles for the Renault brand. The supply chain disturbances were higher in the second quarter than in the first quarter for trucks, but still an impressive result achieved by the whole organization, and the continuous efforts to work really close with our customers and to realize as much as possible of the strong order book. Volvo Construction Equipment deliveries declined with 24%, mainly as a result of lower deliveries in China. While the Volvo brand deliveries were slightly above quarter two level last year. But all in all, a great job.

When it comes to electrification, demand for electric vehicles and machines were increasing and we continue to expand our electric product ranges, and also manufacturing capabilities and maturing our own and our partners' value chains in terms of volume ramp-up. We had a positive book-to-bill 1,700 orders and approximately 1,200 deliveries in the quarter. When it comes to trucks in particular, we did see for orders decline between quarter two last year and quarter two this year, and that was related to last year's opening of the order book for the heavy-duty electric range for Volvo, the FH, FM, and FMX that created a spike that quarter. So that explains, so to speak that year-over-year decline.

But generally speaking, we had a good momentum and we continue to invest in this area. It is, however, very important to state that this is truly societal change where many actors are set to act and invest to support the continuous positive ramp up. And we see that now that the customers are really looking for certainty not only when it comes to the equipment, where they feel more and more certain, but also when it comes to green and consistent generation of energy, when it comes to regional and local grids, charging infrastructure and incentive schemes for early adoption, when we are in the ramp-up. And this is again a call for action. We are ready to do so, and we need to continue to work closely together to continue this positive development.

When it comes to vehicle and machine sales development, the sales was very good in all areas on the back of a combination, and it varies a little bit between different business areas. Number one, commercial conditions, i.e. pricing, but also product content and value creation for our customers; and number two volumes to certain extent; and three also product and regional mix effects. All in all, strong FX-adjusted increase of equipment sales of 12% year-over-year to almost SEK110 billion.

Service sales also continued good demand for services, with strong growth, plus 11% adjusted for currency. This is the result of improved commercial conditions together with a continuous high activity level amongst our customers. Efforts to increase contract penetration and other services that has been seen over the last years are also gradually paying off. Volvo Buses continues to show a strong service sales recovery, while it was less strong for VCE on the back of softer machine utilization in Europe and China. While North America for VCE is stronger year-over-year. But all in all a good result for services. So as we continue to work close with our customers to provide the best uptime and productivity services, service sales are now rolling 12 on SEK120 billion. Also in this area a very good achievement.

When it comes to Group news, in the beginning of July, actually very recent, Volvo together with Westport Fuel Systems have agreed to establish a joint venture for high-pressure gas injection fuel systems. This is down to secure a long-term competitive position for internal combustion engine technology, based on both biogas and in the long run also for hydrogen, so renewable fuels. This ties into our technology strategy for decarbonized transport using also the combustion technology over many years to come complementing battery and fuel cell electric vehicles and machines for certain applications and geographies, such as demanding long haul or demanding offload applications. And that goes also in line what you can see on the right side here that we have revealed on our Capital Market Days, on our technology road maps that we are going for the three different technologies in order to make sure that we can guarantee a strong ramp up for our customers with different type of prerequisites.

Another important event in our efforts to decarbonize our own value chain and operations is that Volvo Group has signed an extensive partnership agreement with Vattenfall to long-term secure renewable electricity with predictable conditions for our Swedish operations. This partnership is a step forward in the Group's commitment to reach a net zero greenhouse gas emissions value chain by 2040, and thereby achieve the aims of the Paris Climate Agreement.

On Trucks specifically, we did see the first Volvo FH electric truck produced in our high-volume plant in Ghent in Belgium, and it has also been handed over to the customer, which is good. So now Ghent is also prepared for ramping up serial production, complementing then our two operations. Volvo Trucks has also delivered an electric truck for heavy transport up to a total weight of 74 tonnes. And this application supports the high-capacity transport initiative.

Volvo Trucks in addition has, during the quarter, in May to be more specific, I had the pleasure to participate, signed a letter of intent to sell 1,000 electric trucks to Holcim, one of the world's largest building solution providers between now and 2030. The deal is the largest commercial order to date for Volvo electric trucks, and the first 130 units will be delivered in 2023 and 2024.

When it comes to truck market forecast, in both Europe and North America activities and also deliveries are remaining high. And with constrained supplies over the last year, it has been continuously important for many customers to make sure that they can renew their fleets and come back to a normal replacement cycle. We therefore increased our forecast of the total market for 2023, both for Europe and North America, both of them increasing with 10,000 units, up to 330,000 total market.

The market in Brazil has been and it was anticipated, of course, softer in beginning of 2023 following the pre-buy ahead of Euro 6 introduction. And here we reiterate our forecast at an 80,000 level. Indian market is recovering and we are therefore reiterating also the stronger market that we already said in quarter one, so 400,000 units for 2023 for the Indian market. And also for Chinese domestic market forecast, we have an unchanged forecast at 650,000 units.

Truck orders and deliveries. We continue to be restrictive in taking orders through gradual opening of the order book to manage the cost inflation pressure and other uncertainties. Having said that, we see some signs of a market that is gradually normalizing in Europe, i.e. gradually moving back to the underlying trend line, so highly anticipated, while North America continues to be strong. All in all, we had a book-to-bill that was 0.76 during the quarter with approximately 48,000 orders and 63,800 deliveries.

In particular, North America had restrictive order slotting due to long lead times. But it is worth noting also that the first six months we see a plus 9% when it comes to the order intake in relation to last year, and plus 6% for heavy-duty medium-duty in Europe. So, also in that regard, we see continuous good activity. At the same time, we will continue to make sure that we have the right balance between order intake, production and deliveries, so we have an order book with right quality to manage on one hand delivery reliability, while at the same time manage inflation and other uncertainties. And we are also keeping a high level of flexibility as always to manage any mid-term changes in demand, such as the expected normalization of demand levels.

Overall, when it comes to truck market shares, we still enjoy good levels. The movement between quarters are mainly an effect of supply situation for us and our competitors. If we start with Europe, we continue with the high levels for Volvo and Renault with close to 27% combined. It was extraordinary high last year, but 27% very strong, and close to 70% on electric only.

In North America, Volvo was somewhat softer at 9.2%, a small improvement sequentially from quarter one from 8.7% to 9.2%, but still somewhat softer on the back of specific supply constraints. And Mack Trucks with a small improvement, almost 6%. And we continued with good level in Brazil of 23% and also in Australia, we did see a strong recovery of the Volvo brand and good levels for Volvo and Mack combined to 27%.

Construction Equipment news, first and foremost compact segment is growing and we have made a lot of efforts in that segments. And Volvo Construction Equipment is now establishing a full value chain, a business unit within VCE for compact equipment machines and solutions to further reinforce that focus on growth and profitability in those growing segments and markets. VCE also continued its roll out of electric machines around the globe, and in particular, in Asia. In the picture here, you can see the launch of electric machines in Japan.

When it comes to the VCE market forecast, continued very strong market in the North America markets where it was somewhat softer market in Europe. China continues to contract. So from a market forecast standpoint, we are increasing North America with 5 percentage points and now have plus 5% in relation to last year as a midpoint. For Europe, South America, Asia excluding China, the forecast is -- the forecast are unchanged in relation to what we said in quarter one. And for China, we now have minus 35% as midpoint, and the forecast is reduced by another 25 percentage points as the market is saturated with Tier 3 machines, hence the Tier 4 market is not taking off and there was not any normal spring season peak.

When it comes to orders and deliveries for Construction Equipment, continued good demand in North America, while Europe is softer, especially in residential buildings, and thereby the excavator segments which is cooling off, articulated haulers and wheel loaders segments remained stronger. Deliveries in North America plus 35% and Europe plus 6% were strong on the back of solid order backlog. While the global deliveries numbers minus 24% are strongly impacted by the weak market in China.

Volvo Buses, demand for new buses continued to improve, in particular, for coaches and electric city buses. Net orders increased by 23%, while deliveries were flat versus last year. Focus on the new business model that we disclosed last quarter for Europe is continuing. And what we will do there is to make the business model very similar to the other parts of the world that has been very successful. Meaning, that we are dedicating our internal industrial and technology resources on the chassis commonality with Trucks to ensure that we can drive innovation and investments in areas to make Buses competitive and leading. And to complement that, our bus organization has done a great job also to secure now a number of strategic bodybuilding contracts with a letter of intent signed with key bodybuilders for the European markets.

Finally, Volvo Buses has secured a large order of 189 buses from Stagecoach in the UK. Penta demand is somewhat softer on the marine leisure side, and in particular, on the lower end of marine, while the industrial business remains strong. Quarter two net orders decreased with 11%, 2023 sold out, so mainly as a result of restricted -- restrictive order slotting. The deliveries decreased by 3% in the quarter, also with somewhat higher supply disturbances. Volvo Penta's highly successful Inboard Performance System, normally called IPS has now also been introduced on even larger vessels and yachts. And this system is also prepared for a range of energy sources.

And finally for Volvo Financial Services, it was a good growth in absolute new business volumes with record business volumes for the second quarter of SEK29 billion. Penetration was stable in a continuous competitive market. And we continue to see a stable portfolio performance on the back of high customer activity levels and demand for transportation and construction services in most part of the world.

So that, Johan, is concluding the business report.

Johan Bartler

Thank you Martin for your presentation. That brings us to the next speaker, which is Jan Ytterberg. Please Jan, take us through the financials.

Jan Ytterberg

Thank you, Johan. The quarter can be summarized as a quarter with strong record earnings when deliveries were high in most of our major markets. Price realization continued to be good across, whereas supply chain disturbances continued, or in the case of the European production system even increased during the second quarter. We also see then a continued cost pressure coming from both inflation and from the transformation.

Moving over then to start to look at the P&L and the top line, the Group net sales, the increase of FX adjusted net sales was 11% and that was mainly related to the price execution to mitigate the cost pressure and also then an improved mix, especially related then to Construction Equipment. Whereas the deliveries actually was somewhat lower in the Group in this quarter compared to the second quarter last year.

If you take a look on the regions and include also the FX effect, we see substantial increases in Europe and North America. And we clearly also see the lower demand in South America. In the case of Asia, the weak construction market and the demand there affected sales negatively, but was compensated by higher volumes and deliveries in other business areas in Asia. The FX effect is substantial on top line as the Swedish krona was weak during the quarter compared to the important currencies for the Volvo Group.

Looking at earnings, just a short statement, you can see that the underlying performance, the strong performance is reflected in the financial figures and the financial leverage as we call it, it's over 50%, i.e., when you compare the FX adjusted net sales when -- with the FX adjusted improvement of adjusted operating income, it is over 50%. That's a very proud and good figure, and that's also compared to second quarter that was strong last year. All in all, adjusted operating income improved SEK8 billion to SEK21.7 billion, giving then a margin of 15.4%.

Similar to last quarter's we are maneuvering in an environment of inflation and transformation. And it's of course very important to adjust the commercial conditions continuously to mitigate this combined cost pressure. And we were successful with the price realization both on vehicles and services here in the second quarter as well, and that, of course contributed positively to the improvement.

We had also good mix as regard products, brand and markets in old and non-Truck businesses, but of course most clearly seen then in Construction Equipment as the mix shift to more of heavier Volvo-branded machines in North America and in Europe with better commercial conditions and then lower and relatively lower volumes into the Chinese market where the price competition is high. And that is, of course, impacting our SDLG brand on Construction Equipment.

On the negative side, we see similarities with what we have presented earlier quarters. We have the material cost that continued to put pressure on the earnings, both as regards to compensation for inflation, but also now compensation for higher salaries at the suppliers, whereas the raw material had a small positive effect in the quarter. We also experienced lower production efficiency in the Group, slightly more of supply chain disturbances across regions and business areas that affected then the cost per unit negatively, and on top of that we have a general higher cost level both on bot services and on the salary side.

And then thirdly also we have the ambition to be in the forefront of the transformation with electrified and autonomous vehicles, as well as a high pace on the combustion engine technologies. And that is reflected in more resources, more activities and thereby also in increased R&D costs. We had a positive net capitalization effect on the R&D cost of plus SEK0.5 billion here in the second quarter. When we look into the coming two quarters, we see a positive but fading effect from the net capitalization.

We also had a positive effect coming from FX on the Group of some SEK0.8 billion in the quarter compared to second quarter last year, SEK500 million of that was related to the transaction exposure. Going forward, we expect to be neutral as regard transaction exposures the coming quarters and we do not provide any full guidance around FX for the total earnings.

In this quarter we had two items classified as significant items affecting comparability and thereby excluded from the adjusted operating income. It is on one hand the SEK6 billion related to customer claims from the European Commission antitrust settlement decision in 2016, where we now have met the requirements to make provisions for part of that exposure, and then we also have as earlier announced, a restructuring provision of close to SEK1.3 billion related to the discontinuing of the bus production in Nova Bus and that is happening in 2025.

Cash flow, second quarter is seasonally a strong cash flow quarter, high deliveries and high earnings and also now then in the second quarter, with the strong earnings we had, we got an operating cash flow in industrial operation of SEK12.6 billion. The supply chain disturbances put mark also in our cash flow with a continued build-up of inventory during the quarter, and the focus now during the vacation period and Q3 is, of course, to take that down. The high ambition and activity level in the Group is also reflected in higher CapEx.

We saw a decrease of financial position in Industrial Operation during the quarter, down to SEK62 billion, mainly then related to the dividend payment of SEK28.5 billion in the month of April, mitigated and partly offset then by the SEK12.6 billion in positive cash flow. Return on capital employed in Industrial Operation in rolling 12-month basis was stable between first and second quarter of slightly over 30%.

If we move over to the different business areas and start with Group Trucks, the increase of truck deliveries was some 5%, and as mentioned, mainly related to light commercial vehicles. Then we also saw a strong service demand, as well as price realization on both vehicles and sales. And that, of course, impacted net sales positively. FX-adjusted net sales were up 12%. And the price realization was the main explanation behind the improvement of adjusted operating income of SEK5.3 billion, up to SEK14.9 billion, giving then an operating -- adjusted operating margin of 15.9%.

And similar to the Group, the headwinds came from the material cost, where we see both increased piece prices and one-time payments to suppliers to compensate for the inflation. And as I mentioned, partly mitigated by somewhat lower raw material cost. We saw the headwinds from R&D expenses that are affecting then by the high ambition in activity level, both related to transformatory technologies, but also to new product development. And as mentioned, we saw a lower production efficiency related then both to supply chain disturbances, but also to a higher cost level. FX impacted positively with SEK0.6 billion in the quarter.

For Construction Equipment, we see yet another quarter with lower deliveries and improved earnings despite substantial lower deliveries in China, net sales increased by 7% FX adjusted, reflecting then the improved product, market and brand mix as mix shifted then towards more of heavier Volvo branded machine in North America, Europe, with comparable better commercial conditions. And then relatively lower deliveries into the price competitive Chinese market. Higher prices impacted positively as well on net sales and the positive mix, and the improved prices, they were the main drivers behind the improvement of adjusted operating income of SEK1.8 billion, up to SEK5.4 billion, giving then a margin of 18.5%.

FX had a small positive effect of SEK0.2 billion, headwinds for Construction came from the lower volumes, both as part of less sales of course, but also combined then with supply chain disturbances with a lower production efficiency. And also here we see high ambitions on R&D and on selling expenses that is impacting -- that are impacting negatively.

Moving over to buses and we see a continued improvement of the bus business also here in the second quarter, where we also experienced a positive mix effect with high coach demand and high deliveries of complete buses in North America and more of electrical buses deliveries in general. Whereas we saw deliveries in South America and Europe decline to some extent.

Service sales increased substantially as the improvement of the utilization of the fleet is happening. Together then with improved prices, this impacted both net sales positively, we are up 26% for Buses and earnings. Adjusted operating income went up to SEK219 million, giving an adjusted operating margin of 4%, and also here we see pressure coming from the higher material cost that impacted negatively, but we had also then a positive FX effect impacting positively then with SEK116 million.

And for Penta also here, we see more of supply chain disturbances. And that impacted the engine volumes. And, of course, the production efficiency negatively, whereas also here we see service volume increasing and continue to increase. Higher prices and a favorable product mix with more sales of integrated propulsion system on the marine side, IPS, and heavier machine -- heavier engines in general that impacted, of course, positively both our net sales and the adjusted operating income. Whereas the cost pressure came from higher material cost, more of activities on the sales side besides then the lower production efficiency that already was mentioned.

Net sales up 11% FX adjusted, adjusted operating income increased to SEK804 million, and we have a margin -- adjusted operating margin of 14.8%. And also here a small positive currency effect of SEK145 million.

We end with Financial Services, the numbers you see on the slides have then been restated to exclude Belarus and Russian operation in the historical figures. The high deliveries of the Group, the favorable mix and, of course, the improved prices on the Group products is also affecting the portfolio growth of VFS positively. New business volume increased 6%, FX adjusted, giving a credit portfolio that ended the quarter over SEK250 billion. The fierce competition from banks and leasing companies is putting then pressure on earnings, but also making our penetration decline, it was on a rolling 12 month basis at 27%. And customer financials and payment performance is still very good, reflected then in low write-off levels and low credit expenses.

We have an improvement of the adjusted operating income up to SEK916 million, mainly related to the portfolio growth, partly then offset by the spread compression that we have experienced the last years. And FX had a small positive effect of SEK59 million in the quarter.

So by that, I hand over to, Johan.

Johan Bartler

Thank you, Jan for your presentation. So, Martin, how would you like to summarize the quarter?

Martin Lundstedt

So Johan, I would like to start by saying that, again, what I started the initial presentation, very proud and humble to present the strongest quarterly earnings ever for the Group. And I would argue that the hard and dedicated work from all colleagues and business partners really have been paying off, not only for the quarter, but I would argue that it's also representing a company that is considerably more resilient and stronger than ever before.

We continue to stick to our priority of delivery of products and services to serve our customers and to execute the order backlog and support the customer's installed fleet. We see that also when it comes to the service development. We continue to see transport and infrastructure activity remaining on good levels in most of our markets, but we are also preparing for a gradual normalization of the demand situation. And we are doing so with a platform of record strong profitability and high operational performance. At the same time, we continue to push innovation investments to stay in the forefront of the transformation. The importance of performing today to be able to transform for tomorrow will be decisive for the years to come.

And by that we end the presentation and we go into Q&A.

Question-and-Answer Session

A - Johan Bartler

Thank you, Martin. So that brings us to the Q&A session, and we please ask you that you limit your questions to two. And on the line, we have Klas Bergelind from the Citibank. So Klas, please go ahead.

Klas Bergelind

Thank you, Johan. Hi, Martin and Jan. Klas at Citi. So my first one is on the cautiousness Martin you highlight there in trucks. Can you talk about the extent you have opened the order book here for 2024. I guess you have opened more in Europe than in North America at this stage. And you talk about seeing customers being more reluctant. Is it more over the road, or is it more construction linked there in Europe as we understand that better. Thank you.

Martin Lundstedt

Thank you, Klas. And first and foremost, I don't think we should over read the word cautiousness. What we see is a little bit, of course, I mean, that some of the orders takes somewhat longer to actually close, in particularly, for smaller customers, that is rather normal in an environment like this also. So, first and foremost, not over reading cautiousness, that should imply a big shift in the market sentiment. What we are talking about is a gradual normalizing of a market that is also highly natural, given the fact that we have had now, and will have also during 2023 an over swing, that is needed also for the replacement cycle and the average age of the fleet.

But if we really look into how the pattern and how the constitution of the fleet looks like, it is, of course, still we see that unused and availability of used trucks. It is still so that there will be a continuous demand of both replacement and coming to a good level also moving forward.

And as we have said, we see some signs of cautiousness, we don't see any clear pattern of it. But we also wanted to be clearer that one point in time, it should be a normalization of the market. And that is what we are signaling early signs on. Having said that, for the first half of 2023, we still have an increase for medium and heavy-duty in Europe of 6%. So, I mean, we still feel confident about normalizing rather than a big shift in the market.

Klas Bergelind

That's very clear. And on the timing of the order book, are you planning -- is it North America 2024, is that more August, September, you hadn't opened yet exactly or...

Martin Lundstedt

You can see that pretty much also -- you can see that pretty much also when it comes to the order intake in quarter two for North America that is weak. And that is related to exactly your comment here that they have been restrictive in opening up for 2024. We always have a little bit different patent for Europe, even if also in Europe, depending on markets and regions, we are also restrictive in order to make sure that we have the right balance and quality of the order book.

Klas Bergelind

My second one, just quickly is on pricing and mix. The Construction Equipment margin is benefiting obviously from the geographical mix there, but can we zoom in on the truck margins, sometimes when volumes soften, you see this price concessions. And I appreciate that this is a normalization margin, but at the same time we go through this tech shift, and I guess it's important for all OEMs here to still make money on the ICE fleet, there should be a little bit more price discipline, I would have thought. Can you talk about how you think about the price backdrop here, Martin as volumes start to normalize?

Martin Lundstedt

Yes. And I would ask also, Jan to comment on it, obviously. But to start with, it has been very important for us also in a good market situation to work with our commercial conditions. We see that we have a good demand. We have a good product. We have good solutions. And the value that, those products and solutions are bringing are, so to speak, justified with the commercial -- with the commercial conditions that we have.

Having said that, we are also firm, and that's the reason why we have built in also a much higher degree of flexibility and also a much higher degree of resilience into our business that the price discipline from us, given also that the value is high should remain, not at least in the light of what you have said. I don't know if you would like to comment on that, Jan.

Jan Ytterberg

No. I think you said it well. I mean, let's see what's happened. It's an oligopolistic market, a few players. We have cost pressure, not only coming from inflation, but also coming from the transformation, which, of course, is acting as a floor for someone taking down their prices.

And also, now I come into in a little more theoretical speech here, Klas, this is becoming more of a business, where the risk is increasing. You are saying that yourself, the transformation, the cyclicality on top of that, that should demand a higher return for the shareholders. And of course, we as managers are reacting on that, and we must increase the profitability to make this an attractive investment case.

Klas Bergelind

Thank you.

Johan Bartler

Thank you, Klas. So we move over to the next person calling, that is Jose Asumendi from JP Morgan. Please, Jose.

Jose Asumendi

Thank you very much and good morning. Just two questions please. Can you discuss a little bit the flexibility of your industrial footprint and maybe just comment a little bit around temporary workers around your truck and construction equipment divisions, in the light of maybe some softening of that order backlog, can you remind us a little bit how flexible is the footprint?

And then second, can you give us a bit more color with regards to the Construction Equipment order backlog? What are you seeing across the different regions? And you mentioned also that you are being more selective on your order intake. If you could give a bit more color on that? Thank you.

Martin Lundstedt

Thank you, Jose. And obviously, this is an area, where we have been working a lot over the last quite many years now with the flexibility. And I should argue that when it comes to the flexibility in our industrial system, we can absolutely host what we -- what we paint out as a possible different scenarios in the midterm. So this is an area, where we feel confident that we have the type -- the right type of response and means. We see that also, by the way, take now Latin America, where we have had a correction in demand anticipated with the introduction of Euro 6. We have been able then to adjust our production levels in accordance, and thereby also keeping a good operational and financial performance of Latin America region, even though that volumes are falling. That's one example.

We did see that also, and we have continued to improve that resilience, of course, during the worst parts of the panic. But temporary and other type of arrangements, other type of flexible tools that we have makes us confident that we can handle, I mean, what we are now anticipating as different scenarios, absolutely.

Secondly, when it comes to the order board for Construction Equipment, as we said, we did see good deliveries, both for Europe and North America based on that we have a very strong order book. If anything, the softening and maybe the more -- clear softening that is also related to what you can see in other industries, for example, the residential construction is in Europe and mainly then on the excavator side. But on haulers and wheel loaders, we still see a strong demand, where also -- Volvo has a strong position.

Then obviously, what we feel encouraging to see is that it is also shifting the construction segments towards a lot of other investments now away from residential, for example, in the energy sector, et cetera. So North America remains very strong. And so to speak, the lower order intake was purely related to restrictive order slotting.

Jan Ytterberg

I can just add there, Martin, we don't expect any fall off the cliff situation, as it relates to demand. This will be more, as we see it, more than normal, if something is normal business cycle setting that will take longer time, but not be as brutal as we experienced during pandemic or financial crisis, which, of course, makes flexibility possible to handle in a good way.

And just a remark. I mean, if you're a little financial savvy, you can just look at -- in our non-controlling interest in our income statement, and you can see that SDLG despite losing 50% of their deliveries are making money, so there you can talk about flexibility. And of course, it's different flexibility in different parts of the world.

Johan Bartler

Very well. We're moving over to next caller from Stockholm, Erik Golrang from SEB. Please go ahead, Erik.

Erik Golrang

Thank you. Two [easy] (ph) questions. The first one on the SEK6 billion reservation there for claims on the antitrust side. Does that cover your assessment of all of the 3,000 claims in so far, or only a part of them?

Martin Lundstedt

Yes. It's only -- as we also -- also stating it is covering a part of the ongoing processes since we are also keeping a contingent liability, as regards these -- those processes.

Erik Golrang

Okay. So it's -- you're likely to assess more of those resources and then potentially further coming in, in the coming quarters. So that's a possibility, at least?

Martin Lundstedt

Yes. That is a possibility given that we're utilizing the same methodology, as we have been using in this specific assessment that are meeting then the requirements for making a reservation.

Erik Golrang

Okay. And then on the pace of BEV penetration, still early days, clearly the tough comp on BEV orders in the quarter. Could you say something about the general eagerness in the market? Are we started to see some of the previous concerns of constraints there holding that BEV orders, charging infrastructure availability raise concerns through similar. Or what's the general trend and discussions you have with our clients setting momentum here for next year and so on?

Martin Lundstedt

Thank you, Erik. No, I think it's fair to say, and that has also been expected from our side that we will see a demand curve that will move a little bit up and then sideways and then up again, and there are several factors for that.

Number one, to your point, I mean how does it go for customers for different segments to see that it's a viable option. What we have seen so far, of course, is a lot of adaptations when it comes to urban transportation, where the transporters can control this by, for example, their own depot charging. We have had also the geopolitical crisis with the war and the energy situation, making people holding on a little bit to what is known because this is still an unknown territory, how will it really work in the long run. And we have been very clear, and I also said that in my presentation that it is important to have a coordinated then effort to your point for charging, but also for grid capacity, where we also have a lot of conversations, regeneration of energy, et cetera.

Having said that, we see that the rule is -- a fourth element maybe just to -- is also that some of the incentive schemes that has always also been important to pro-pulse the early adopters have been a little bit dragging in times when it comes to the applications and the answers for some of the major markets. So natural conditions in an early market. We are convinced that it will continue to take off.

But we are also convinced that we have built into our system, and that's the reason why we have the mixed model assembly that we can actually produce that together with our other models, both of diesel and biogas and others is that we need to have that flexibility because demand will come in different type of steps. But again, very important and good for us to be early out to learn also not only when it comes to the products, the execution, but also the business model.

Erik Golrang

Okay, thank you. And then the final question, a follow-up on the profitability discussion previously. Any sort of reason any clear negative factor in the earnings bridge coming quarters, aside from seasonality, I guess, into the second half and also potentially weaker volumes. And if there's a potential parallel to be made to Penta, which saw a quite big drop in quarter-on-quarter margins, as volumes deteriorated a bit?

Jan Ytterberg

Well, regarding Penta, and I mentioned that they had more of supply chain disturbances in this quarter, and that is, of course, also affecting their performance in the quarter. For the rest, in coming quarters, we see sort of the environment that we are maneuvering in will continue for third quarter and fourth quarter. But of course, with the question around inflation with disturbances, et cetera, so we have to be flexible to handle the situation. But I think we have been doing that in a good way so far.

Erik Golrang

Pretty good. Thank you.

Johan Bartler

Very well. Thank you for that. Next one on the line is Daniela Costa from Goldman Sachs. Please go ahead, Daniela.

Daniela Costa

Hi, good morning. Thanks for taking my question. I have two as well. The first one I wanted to follow up on your comments of regarding sort of margin flexibility and resilience and maybe ask you, I know 2020 is not a normal year or a normal downturn in any sense, but provide us I guess some views on how the drop-throughs were, and trucks were still much more sensitive than CE back then. So can you comment that sort of when you talk about resilience, is there a difference of what you consider resilience on a normalized slowdown between trucks and CE, do you think CE is going to be much more resilient going forward. I mean maybe perhaps if you help us calibrate how to think about trough margins in both businesses?

And then the second question, just regarding, I mean historically you have talked about what was the operational cash that you needed in the business, I think back in the past you mentioned something like SEK30 billion, you seem to emphasize a lot that you have investments to do maybe more than you emphasized in the past and now you, you become involved in things like cell manufacturing. For example, what is the operational cash do you think you need going forward, has the number changed or it's still the same number as in the past? Thank you.

Martin Lundstedt

Thank you, Daniela. And to start with then the first question here on -- I mean, from a more general statement, I mean, since I think we all can agree that peak margins, whatever -- whenever and whatever the peak would be, has considerably improved for the Group. We also anticipate that to be true for the trough margins both from, I mean, a general uplift, but also for continuous efforts, what we have already discussed on flexibility and speed in order to adopt, but also the service proportion of the business that is continuing also to increase. So that is number one.

Then when it comes to the difference between CE and trucks in 2020, I should argue that it was not due to that CE -- CE had a better resilience. I think both showed exceptional resilience already back then, and we are continuing to improve that. The reason was obviously that China and Korea, to some extent, was -- were open much longer than the main markets for trucks, meaning that we see that the time could mitigate volumes better and didn't have that huge volume drop that we did see on the truck side. So if we compare like-for-like, I should argue that it's a very similar type of resilience.

And if anything, also on the truck side that we have continued also to increase our contract penetration and thereby also our service content considerably. So I think that is my response on the first question.

I don't know if you would like to add something.

Jan Ytterberg

You're right. I mean, flexibility in general, you mentioned the pandemic situation, of course, very special we -- and we are, of course, planning for the worst and hoping for the best. But what we see right now is more of a sort of a longer situation, but not a dramatic fall of demand, and, of course, our planning for all alternatives.

Coming back to what you said, the service penetration, the service, sales, et cetera, will be very important because as long as the vehicles are up and running, it's very good to have that buffer to work from.

Martin Lundstedt

And we should remember -- and we should remember, of course, also that -- I mean, here, we are talking about -- I mean, when we are talking about normalization, we are talking about coming back to a trend line that is still very attractive when it comes to volumes. Now, we have had also a situation, where we are saying, yes, it's good.

When it comes to the volumes, we are expecting a volume market, total market of 330,000. And for us, if we just look into quarter two, we didn't have any volume increase for heavy-duty and medium duty, and so it came from LCV. So in a way, we see that the industry as a whole is catching up, but we had a very good quarter last year and outperformed. But having said that, I mean, when we are talking about the normalized market, we are still talking about good levels and attractive levels for the Group and for our customers. So I think that is very important to have in mind.

The other thing that we are talking about is, of course, our opportunity to actually optimize efficiencies also. We have that as a headwind now. Production efficiencies, it's capacity utilization, there are a number of extraordinary costs coming into the system, et cetera. So there are always also positives when you're seeing more steady correction that we are anticipating, if and when that will happen.

And then when it comes to investments, I should not say that both when it comes to financial position that we don't see any material or we don't have changed any material view on what is a good level for the Group in order to keep maneuverability. We feel that, again, the resilience and the performance of the Group will make it possible for us to -- and I think the quarter two is really showing that.

We have record earnings. We have, at the same time, as we are continuing to pursue and to really forge a strong future, thanks to good and important investments in technology, in digitalization, in our industrial and commercial footprint, and that is how it should go, and we are producing a return on capital employed, including one-offs, 30.2% rolling 12.

Johan Bartler

Very well. Thank you for that. We are moving over to the next person on the line, which is Agnieszka from Nordea. Please go ahead, Agnieszka.

Agnieszka Vilela

Perfect. Thank you. So my first question is on the orders development. It seems that you might be a bit more restrictive in taking orders compared to your peers. And my question is whether you are not concerned with the risk of losing some market share. Maybe we shouldn't read too much from Q1, but your market shares have declined.

Martin Lundstedt

Yes. Yes, it has -- and thank you, Agnieszka. I think there are different patterns then in different main markets. And if we start with Europe, and I think you know it really well. Also we had exceptionally strong market shares in both first quarter and second quarter last year for Volvo and Renault combined. Of course, we would love to keep that. But we also knew that, that was a very, very strong growth. We still see with 27% combined market share in Europe that is very -- is a strong and good position for the Group.

In North America, specifically, even if we did see sequential improvement for Volvo from 8.7% to 9.2% market share, we have had some specific disturbances for the brand, not related to the fact that we have lower -- slow order intake. And we have gradually seen improvement of that situation also during the course of the quarter. So we are expected also that to come back.

So again, I should say -- I should argue -- and Brazil, by the way, also, I mean, from 25% to 23%, we were sold out with Euro 5. That was the right strategy. We entered the year with Euro 6, keeping 23%. That is also a very high level for us historically. So it's the right thing to do in the shift of emission. So I think we should feel good about the market shares, as they stand.

Jan Ytterberg

And I think Martin, this was expected. I mean, we have had as a strategy to deliver, deliver, deliver to our customer promise and taking on extra cost to doing that. So we have been pretty well in actually executing on that. And of course, when supply chain disturbances are easing up in general, the others will sort of take back part of that market.

Martin Lundstedt

And maybe the last comment Agnieszka, also to what you said regarding orders and our order slotting pattern, I just for curiosity last night, looked at that. And first half of last year we had I think 0.86 in book-to-bill. And I think we had exactly the same this year then with a slight increase of total numbers obviously with some 7%, 8%, 9%. So we have that seasonal patterns also been and then primarily also to, I think it was Klas question regarding how we are opening the order books in primarily then North America where when it's sold out, then it's coming then from an order intake point of view a little bit later during the year.

Agnieszka Vilela

Perfect. And then my last question is on the profitability headwinds in the quarter. Obviously, you had very strong margin in Q2, but you still mentioned some headwinds through EBIT, including higher material costs and also the supply chain issues. So if you could comment on these two headwinds, what you're seeing now and where we should expect lower material costs to start to fit in into your results and also on the supply chains, if you see any easing as of yet?

Jan Ytterberg

And I think what we will see in the society in general is a higher inflation and that will not come back to 0% or whatever we consider as being normal, looking at the rear mirror. We will have a higher inflation, and thereby sort of need to adjust our commercial conditions to that pressure we get from inflation, both in our own system, but of course, also from the supplier side.

Then on the production efficiency, of course, also here, it's a combination of a higher cost level and then the production disturbances we had, and they were sequentially then increasing, especially if we talk about Group Trucks. Where we will go from here? Well, I do not really know. We will have to see. But as Martin mentioned, in parts of the world, we saw during the quarter, a somewhat better situation. But where we are going from here, it's difficult to say.

Martin Lundstedt

But maybe also you can argue we are often discussing this, I mean, when you're looking at a bridge, then of course, you are looking at that functional. I mean, you can argue that, I mean, our price realization, commercial realization is linked to the material cost also because that is the general pressure in the system. And there we have been successful and ahead of the curve. And that depends then on how we will continue to develop obviously.

I think what is more important for us is or that is important obviously and we have a good methodology. But what is an opportunity is of course the production efficiencies where we have a lot of -- to your point, still disturbances, stop and go, rush transport, overtime, uncertainties, stop days, et cetera, where I mean again the normalization, whenever that will happen because we still have a high order backlog, is an opportunity for also our -- for our financials.

Johan Bartler

Very well. Thank you for that. We take one final call. And that comes in from Olof Cederholm from ABG. Please go ahead, Olof.

Olof Cederholm

Thank you very much. Hello, gentlemen. I have a question on what drives demand really. We have a cost inflation environment, where trucking companies seeing a lot of wage inflation, and then they can invest in a truck, which saves them a lot of fuel. And do you see more willingness from your customers to pay more for a truck because they save more of the life of the truck? Is there sort of a new dynamic here or an increased dynamic of this that you think will last or how do you see this?

Martin Lundstedt

Yes. I think you are -- I think at large, I mean, this is, of course, a lot of different parameters, and it depends on region and application and so on and so forth. But largely, I think you're still -- that you are on the right spots here, Olof. I think, first and foremost, that the transformation is such has actually matured the whole discussion about what does TCO -- how does the TCO, total cost of operation, what are, so to speak, the income and revenue opportunities for me as a transporter depending on how I think about my fleet, and what I stand for, et cetera. So that in itself has matured, so to speak, the discussion about the TCO moving away from the pure capital and investment costs and much more into the -- also to the variable cost, including then fuel efficiency.

Also, to your point, driver attractiveness, super important. We feel that also that we see when I talked about that in my presentation, it is about pricing and commercial conditions, but that is not pricing, pricing only that we are sending out a price letter, if I put it like that, it is also about a different content per truck when it comes to take rates of safety options, fuel options and other type of options and take rates, et cetera. So I think that there is a certain -- I should not call it shift, I rather use the word that you said that is increased or enhanced dynamic into that direction.

Jan Ytterberg

And what we can add, Martin, is that this truck fleet is getting older. I mean, with us being unable to supply against the replacement demand for several years now. We don't have any used trucks more or less, still that is the situation. So what we see is a sort of lower sales of used trucks, it's only related to volume, not to price. So there are a lot of old vehicles out in the streets. And of course, that is a good business case to change them to a new one, as long as, there are access to credits and the financial performance is decent for our customers.

Olof Cederholm

Excellent. Thank you. And then my last question would be on the service sales outlook. And you -- even if you've been supply constrained you have and the industry has delivered a lot of trucks over last couple of years, that I guess should be more valuable in terms of service sales of the coming two, three years. How is your view going into 2024, 2025. Do you think you'll have a situation where you can maybe outgrow general volumes on the market or will you just -- will the service business move with the cycle just as it has been in the past?

Martin Lundstedt

No. I think this is a very good and important question. And first and foremost, I mean, you have a slower movement of the service business. I mean, the volatility is never as high, as it is for equipment even that we are not talking about what we expect now, I mean, more of a normalizing of new equipment deliveries in that case. So services, for sure, with -- to your point, high deliveries into the market, better contract penetration and a better level of the contracts also, that has been a very consistent work, that is gradually moving into the market of the installed fleet. So from that regard, we expect services to be highly resilient in a market that will continue, as it is now or if it will gradually normalize services, absolutely will continue to be a strong driver.

Olof Cederholm

Thank you. And on that note is the services business still clearly more profitable than the equipment business?

Jan Ytterberg

Yes.

Olof Cederholm

Thank you. Thanks a lot.

Johan Bartler

Very well. Thank you very much. That concludes the Q&A session. All materials that we've looked at today is available on the Volvo Group homepage. That finalizes the Q&A and this quarterly press conference.

Martin Lundstedt

Yes. And we just would like to wish everyone a nice summer. I think we are all worth it.

Johan Bartler

See you next quarter.