CEO's Comments

Tough third quarter

During the third quarter, sales for the Volvo Group were impacted by the weakening in demand that has become increasingly evident around the globe. To respond to declining demand and increasing inventories, we decided to adjust our production rates down in several parts of the company. Net sales for the Group declined to SEK 69.1 billion, compared to SEK 73.3 billion in the year-earlier period. The operating income for the third quarter amounted to SEK 2.9 billion (5.8) and was adversely impacted by under absorption in the industrial systems in the range of SEK 1 billion and another SEK 1,060 M of negative non-recurring items. Adjusted for the non-recurring items, operating margin was 5.8% (7.9).

Trucks: slow demand in the quarter, but expectations of unchanged markets for 2013
Compared with the third quarter of 2011 the Truck operation’s order intake declined 25% to 45,300 trucks. At the same time, deliveries fell 8% to 50,500 trucks and net sales declined 7% to SEK 44.3 billion. Operating income amounted to SEK 1,695 M, including negative non-recurring items of SEK 1,060 M. Operating margin excluding non-recurring items was 6.2% (8.4%). The weaker profitability was attributable to lower sales and under absorption of costs in the manufacturing system in the range of SEK 600 M.

In Europe, the weak demand has spread from Southern Europe to an increasing number of countries and the normal pick-up of order activity in September was muted. During the third quarter, order intake fell 28% to 16,100 trucks and for our Renault Trucks brand, which has its core markets in Southern Europe, it is necessary to adjust production rates downwards. The uncertainty in the economy makes it difficult to predict the market, but our best assessment is that the total market in Europe 29 will amount to approximately 230,000 trucks this year, which is the same forecast as earlier. Our best assessment for 2013 is that the total market will be on the same level as in 2012.

In North America, US customers still have a need to renew their fleets. However, today’s market is characterized by customers being cautious ahead of the presidential election and the outcome of the federal budget discussions in order to have a better understanding of the overall economic conditions in the beginning of 2013. This wait-and-see approach impacted order intake, which declined 33% to 7,900 trucks. We maintain our assessment that the North American market will amount to approximately 250,000 vehicles this year. The trend for 2013 is difficult to predict but our current forecast is that the market will amount to approximately 250,000 trucks, however with a weak start to the year.

In South America, the Brazilian market has had a weak development for most of the year, but there are clear signs of recovery. A contributory factor is the Brazilian government’s measures to subsidize interest rates to stimulate demand for new trucks. The forecast for a Brazilian heavy duty truck market of approximately 90,000 vehicles in 2012 remains unchanged. During 2013, the market is expected to grow somewhat and amount to approximately 95,000 trucks.

In Asia, order intake declined 19% to 11,100 trucks during the third quarter. Following a strong upswing during the first half of the year, the Japanese market weakened during the third quarter. Based on the strong trend during the first half of 2012, we retain the forecast that the Japanese heavy-duty truck market will amount to approximately 30,000 vehicles in 2012. For 2013 we expect the market to remain flat at about 30,000 trucks.

Construction Equipment: weak trend
As we described already in the report for the second quarter, Volvo CE noted a decline in demand in an increasing number of markets throughout the world, higher inventories among our dealers in Europe and China and stiffer price competition. Against that backdrop we decided to reduce production rates. When markets subsequently weakened further, especially demand from the mining industry, we were forced to cut production further. As a consequence of the substantially reduced production, the under absorption of costs in the industrial system was considerable. Combined with increased price pressure and a negative trend in the product mix resulting from lower demand in the mining segment, this has meant that the operating margin has been under increasing pressure. However, it is positive that we in this declining market have managed to reduce both our own inventories and those at our dealers for five consecutive months.

Sales in the third quarter declined 9% to SEK 13.3 billion. At the same time, the operating income fell to SEK 650 M (1,438) and the operating margin to 4.9% (9.9). Under absorption of costs in manufacturing were in the range of SEK 400 M. Based on the weak trend in the global economy, higher industry inventories and increased price competition, the pressure on Volvo CE’s earnings is expected to continue in the fourth quarter. Based on the slowdown in demand, we already during the summer started activities to reduce overall costs within Volvo CE.

Volvo Buses, Volvo Penta and VFS
Buses reported a loss of SEK 58 M in the third quarter in the wake of declining volumes, intense price competition in Europe and low capacity utilization. The weak market trend and the stiff competition has lead us to take a policy decision to close production of buses at our plant in Säffle, Sweden and concentrate the production of complete buses in Europe to the main facility in Wroclaw, Poland. The measure is needed in order to reduce costs and turn around the negative profitability trend.

Despite a sales decline in the third quarter of 17%, Volvo Penta reported an operating margin of 8.5%. Lower costs largely offset the negative effects of the lower volumes.

The customer-financing operation in Volvo Financial Services had a continued positive profitability development, with an operating income of SEK 383 M and a return on shareholders’ equity of 10.9%.

Following the end of the quarter, the divestment of Volvo Aero to GKN for SEK 6.9 billion was concluded. The divestment is expected to generate a positive non-recurring effect on operating income totaling approximately SEK 300 M in the fourth quarter, while the financial net debt will decline by approximately SEK 5 billion. I want to take the opportunity to thank all employees at Volvo Aero for their contributions to the Volvo Group through the years and wish them all the best in the future.

Focus on inventories and cash flow in the fourth quarter
Our inventories of trucks and construction equipment are currently too high in some markets at a time when order intake has weakened and price competition has increased. Therefore we will be reducing production rates further and we have high readiness to make more cuts if demand continues to weaken. This will lead to an under absorption of fixed costs in our manufacturing system, but it is important for us to reduce inventories to the correct levels going into 2013 and to improve our cash flow. In accordance with our new strategy, we are also reviewing fixed costs in areas like IT, research and development as well as selling and administrative expenses in order to reduce them during 2013.

High activity level to implement the new strategy
We continue to have a high speed in the implementation of the new strategy to leverage sales and improve profitability. During the quarter we announced the stop of production of UD trucks for the North American market due to insufficient profitability and in Japan we launched a voluntary leave program aimed at reducing the overall cost level by 10% and improve competitiveness. The application period for the voluntary leave program in Japan has ended and compared to mid-2012 the organization in Japan will from January 2013 be reduced by around 950 employees and consultants.

We have also announced that we intend to reorganize Volvo's and Renault Trucks' distribution networks and sales and marketing organizations in Europe, the Middle East and Africa to achieve a more cost-efficient organization that can better utilize the potential in the Group’s brands. We see large opportunities from the integration of the service networks in markets where we have not succeeded in building a sustainable market presence. By joining forces we can increase network density, which will make it possible to sell more and improve customer service. The reorganization is expected to incur restructuring costs of approximately SEK 900 M, beginning in the fourth quarter this year. The costs savings benefits from the reorganization are anticipated to have gradual impact from the second half of 2013 and onward. Together with the actions we have taken in Japan, they are part of the strategic objective in Trucks to decrease wholesale selling expenses to 5% of sales.

Yet another important step was the launch of the completely new Volvo FH truck, which is one of the most important products for the Group. The new truck series shifts the boundaries for what a premium truck can offer. Fuel economy, operational reliability, ergonomics, vehicle dynamics, active and passive safety and time-saving functions – the new Volvo FH is a truck that is built based on the driver’s needs and with a focus on increasing profitability for trucking companies.

In order to further improve our competitiveness in the Russian market, we decided to invest SEK 800 M in cab production at our plant in Kaluga. This will reduce our logistics costs as well as increase the level of local production. A high level of local production has become increasingly important in order to be cost competitive in this large and growing truck market.

In the short term, we have a tough quarter ahead of us to manage the consequences of the slow demand in the third quarter. However, with the production adjustments we are currently implementing, we believe we will have the right level of capacity going into 2013. At the same time we continue to have a high speed in the execution of the activities that are part of our new strategic objectives aimed at improving the overall profitability of the Volvo Group.

 

Olof Persson
President and CEO