CEO's Comments

Strengthened focus on core business

The Volvo Group’s sales continued to grow during the second quarter. Net sales rose 6% to SEK 83.9 billion – representing the highest sales so far for a second quarter. The downturn in Brazil and Western Europe was offset by growth primarily in North America, as well as by higher sales in Eastern Europe and Africa. Operating income totaled SEK 7.3 billion, which includes a positive impact of SEK 495 M as a result of VAT credits in Brazil. The operating margin of 8.7% is slightly lower than the year-earlier quarter, due primarily to a change in market mix. The operating cash flow amounted to a positive SEK 2.5 billion.

After the first quarter, we have taken two strategically important steps. One of these was the sale of Volvo Aero. At the beginning of July, we concluded an agreement to divest Volvo Aero to the UK engineering group, GKN, for an enterprise value of SEK 6.9 billion. GKN is a major player in the production of aircraft components. Volvo Aero will be a part of its core business, and be capable of capitalizing on synergies with its other operations. Meanwhile, we will free up capital that can be utilized to expand our core operations, notably in growth markets such as Asia.

The other step was that we signed an agreement to increase our shareholding in the German engine manufacturer, Deutz, from 6.7% to slightly more than 25%. The price for the shares is EUR 130 M and the purchase will make Volvo the largest shareholder in the company. For many years, Deutz has been our strategic partner on medium-duty engines for construction equipment, a segment in which they are specialists. We are also studying the potential of cooperating with Deutz in establishing a joint venture company in China for engine production to support our growth in construction equipment.

Weaker demand for trucks
The second quarter saw truck deliveries decline by 2% to 58,800 vehicles. Lower deliveries to markets in Western Europe and Brazil were almost offset by increases in North America, Africa and Eastern Europe. Net sales rose 3% to SEK 51.3 billion, which was due to advantageous exchange-rate movements. Operating income totaled SEK 4.1 billion and the operating margin was 8.0%, including SEK 314 M from the VAT credits in Brazil. The decline in profitability compared with the year-earlier period is due primarily to the change in market mix, with a lower share of sales in Europe and Brazil.

The total order intake amounted to almost 53,000 trucks during the second quarter, representing a decline of 19% compared with the second quarter of 2011. The decline was mainly driven by the North American market, which had a very high order intake in the second quarter of last year, and a further weakening in Southern Europe.

During the quarter, the Northern and Eastern European markets continued on relatively good levels, so the overall demand for Volvo trucks in Europe remained stable. On the other hand, we noted a continuing decline in demand for trucks in Southern Europe and a more cautious approach by customers in France. This adversely affected demand for Renault trucks. Given the reduction in production at the beginning of the year and the additional adjustments that we continually make, output is balanced with demand. We retain our assessment that the market for heavy-duty trucks in Europe will amount to about 230,000 vehicles in 2012, even though the market during the latter six months of the year is difficult to forecast, not least in view of the macroeconomic background.

In early July, we announced a new engine designed to meet the emissions rules to be introduced in Europe as of 2014. The engine, which offers major environmental benefits, will be used in Volvo trucks in early 2013. Compared with current engines, emissions of nitrogen oxides are cut by 77%, along with a halving of particulate emissions from already low levels. Thanks to this development, our diesel engines will offer close to zero emissions of nitrogen oxide and particulates.

In North America deliveries rose by 34% to 13,800 trucks, while the order intake declined as a result of customers making substantial orders at the end of 2011 and the beginning of 2012 and have now adopted a more cautious stance in terms of orders as a result of growing concerns regarding the US economy. Current lower demand means that we are manufacturing at a pace which is slightly too high and are preparing to balance production to meet current demand during the autumn. Also in the case of North America, it is difficult to assess the second half of the year but we retain our assessment that the overall market will amount to about 250,000 heavy-duty trucks during 2012.

As expected, the Brazilian market during the second quarter was adversely affected by the transition to stricter Euro V emissions, along with the slowdown in the Brazilian economy. Our deliveries in South America decreased 27% to 5,500 trucks. The Brazilian government has introduced measures to stimulate the economy and subsidies to increase investments in, for example, trucks. However, these actions have not yet had any major effect. During June and July, we reduced production to meet current demand. Due to lower demand during the first half of the year and the considerably lower growth in the economy, we have reduced our forecast of the overall Brazilian market from about 105,000 heavy-duty trucks to about 90,000.

Meanwhile, in Japan deliveries of heavy-duty trucks rose a full 76% during the first six months, supported by tax subsidies for investments in new trucks and because of low truck deliveries last year in the wake of the earthquake. Subsidies have now ceased and, thus, we expect a weaker latter half of the year. Nevertheless, due to the high demand at the beginning of the year, we retain our forecast of a total market of about 30,000 heavy-duty trucks in 2012.

The Indian market has weakened, but VECV – our joint venture company with Eicher Motors – continued to progress well, with increased market shares, good sales and high profitability. In the rest of Asia, demand remained stable, although we see signs of falling demand in the mineral and mining industries.

Volvo CE reported a strong performance 
During the second quarter, Volvo CE’s sales rose 15% to SEK 19.7 billion amid a global market in which most regions, except for China, showed continuing growth. Meanwhile, operating income increased to SEK 2.6 billion, representing an operating margin of 13.3%. The favorable profitability trend is partly attributable to a competitive total solution of products and services, along with good cost control. In addition, earnings were supported by positive non-recurring items corresponding to SEK 161 M, along with a favorable trend in exchange rates. 

Sales growth continued to be robust during the quarter, notably in North America. In Asia, we managed to offset a sharp decline in the overall market in China by continuing to gain market shares, while demand in Southeast Asia remained strong.   

Over the course of the quarter, it became clearer that growth was weakening in an increasing number of markets, and we note a trend towards higher inventories among our dealers in Europe and China, combined with stiffer price competition. As a result, we have decided to reduce production rates in our European and Chinese plants, and we are also downgrading our forecast for the European market. We now expect the total European market to be on approximately the same level as last year. 

Our dual brand strategy has proved highly successful both in China and Brazil. To date in Brazil, SDLG has only sold wheel loaders, but we are now taking the next step and plan to launch a range of SDLG excavators that will be manufactured in our Pederneiras plant.

Lower sales impact profitability for Volvo Buses
Volvo Buses’ sales dipped 5% to SEK 5.2 billion. Operating income totaled SEK 176 M, including SEK 50 M from the VAT credits in Brazil. The operating margin was 3.4%. Volvo Buses’ profitability was adversely impacted by low demand in Europe and North America. Very stiff competition and low capacity utilization has led to considerable price pressure for city buses in these markets. Meanwhile, in Brazil, demand for buses with the new Euro V engines has not gained momentum since the introduction of the new emissions regulations in early 2012. We have taken actions to reduce the capacity in the industrial system in Europe, North America and South America.

However, the Group’s hybrid buses continue to make global progress with inroads into Brazil and Mexico. To date, we have sold 760 hybrid buses worldwide. In view of the fact that fuel savings can be as high as 35%, we are convinced that an increasing number of metropolitan authorities will seek hybrid buses, and we have a strong position in this future segment.   

Good profitability in Volvo Penta, Volvo Aero and Volvo Financial Services
Volvo Penta reported operating income of SEK 268 M for the second quarter, including SEK 69 M from the VAT credits in Brazil. The operating margin was 12.1% during the quarter which is seasonally strong in the marine aftermarket. Sluggish demand for marine engines in Europe in the wake of the protracted crisis in the European economy was offset by competitive products and internal action programs to reduce costs.

Volvo Aero continued to report good profitability, with an operating margin of 15.7% primarily as a result of improved productivity and a favorable currency exchange rate development.

For our customer-financing operations via Volvo Financial Services, the credit portfolio continues to expand, in parallel with an improvement in profitability. The return on equity during the second quarter approached 10%. Despite a weak economic trend in Southern Europe and slowdowns in Brazil and China, the portfolio developed well.

Finally, in parallel with focusing on our customers, we are working intensively with the reorganization in order to improve the Group’s efficiency and better capitalize on the potential of our brands and products. Currently, the focus is on identifying the areas that offer potential for efficiency enhancement. Moreover, there is also extensive work to optimize the brand positions for our brands in the truck operations, which is expected to be completed by year-end.

Olof Persson
President and CEO