Sandvik AB (SDVKF) CEO Stefan Widing on Q3 2020 Results – Earnings Call Transcript

Sandvik AB (OTCPK:SDVKF) Q3 2020 Earnings Conference Call October 16, 2020 7:00 AM ET

Company Participants

Emelie Alm – Investor Relations

Stefan Widing – President and Chief Executive Officer

Tomas Eliasson – Executive Vice President and Chief Financial Officer

Conference Call Participants

Klas Bergelind – Citi

Magnus Kruber – UBS

Gustaf Schwerin – Handelsbanken

Gael Bray – Deutsche Bank

Daniela Costa – Goldman Sachs

Max Yates – Credit Suisse

Andreas Koski – Nordea

Olof Larshammar – DNB

Lars Brorson – Barclays

Joel Spungin – Berenberg

Operator

Emelie Alm

Hello, everyone, and welcome to the presentation of the Third Quarter Results of Sandvik. We will go through the presentation, followed by a Q&A session. And my name is Emelie Alm, and with me today, I have our President and CEO, Stefan Widing; together with our CFO, Tomas Eliasson.

So with that I’d like to hand the call over to you, Stefan.

Stefan Widing

Thank you, Emily. We will stay in this picture for a few seconds. This is our auto mine concept, is a fully automated battery operated electrical loader. We showcase this at the digital event a couple of weeks ago. It is a concept. But it’s real. It’s live and it’s fully working. If you haven’t already seen it in operation, I encourage you to go to social media platforms. And you can see a video clip of this operating in our test mine in Tempera. I think this is a fantastic piece of technology that showcases the technology leadership that our SMRT business have in this industry.

Before I go into the Q3 results, I also want to comment a little bit on the other announcements that we have made today. First of all, the Board has decided to proceed with the process of preparing SMT for a separate listing on the nasdaq.com Stock Exchange. We believe this is the right thing to do both for SMT and the rest of the Sandvik Group. We are aiming to do this in a way that we presented to the shareholders for a final decision in 2022, provided that the circumstances are dim right at the time. Why 2022? Well, the process itself will take about 15-months to complete and then we are late 2021 early 2022. And given the current market environment as well, we don’t feel the need to do this in a hurry. So we’d rather wait a little bit longer and aim for a 2022 listing.

We have also announced that we are preparing for forming a new business area. We will based on our crushing and screening division, create a business area called Sandvik Rock Processing Solutions. We see further growth opportunities in this area; they are operating in a separate part of the value chain compared to the other SMRT divisions. And we also believe that we can increase the transparency of both of these businesses and how they are performing. So overall, we believe this is a positive step forward. This we aim or we will do at January 1st in 2021. And for both of these, we will of course also talk more about these announcements on our capital markets day on November 3. So please join that one as well if you want to learn more.

If we go into the quarter, this has been a quarter characterized of a gradual recovery. But it has also been a mixed picture depending on what end customer segment or geography we are looking at. In SMS, we have seen a gradual recovery in particular driven by automotive and general engineering, while aerospace and energy has been characterized by flattish development versus earlier quarter. In SMT, of course, continued headwinds related to oil and gas CapEx, while for example, industrial heating is having a positive development year-over-year. And then finally, on the mining side, we have a robust development in the quarter; orders are even up versus prior year, driven by good order intake and equipment with some headwind in aftermarket that I will come back to.

In the still fairly tough market conditions, we execute strongly and deliver a resilient earnings performance, a margin of 17.3% down 100 basis points versus last year, entirely driven by currency. This is of course, supported by strong savings, both permanent and temporary in the quarter of SEK 1.4 billion and our adjusted rolling 12-months EBIT figure is now at 16.8%, so well above our trough margin target. We also execute well on the cash items, continue to reduce inventory, and have good control over AR leading to SEK 4.9 billion in cash flow in the period. And we are now at a very low net gearing at 0.5. We have announced in concluding one acquisition in the quarter as well and two divestments the Gesac joint venture that we have in China, as well as the exploration business in SMRT.

If we look a little bit into the future, we expect the gradual recovery to continue. However, as long as we are in a pandemic, we expect market condition to remain uncertain, depending on how things develop in the overall world and the economy. We are focusing on what we can influence and are focusing now on shifting some of our temporary savings into permanent savings to ensure that we are ready for the business activity we expect going into 2021.

Looking then a little bit on the market development here; we can see that our main markets Europe or North America are down around 20%, Asia much better with minus four, but this is also mixed picture. Rest of Asia is more in line with Europe and North America while China is plus eight in the period, so China is bringing up the Asia picture in a quite significant way. The other regions more mining driven are flattish, or in the case of Australia up significantly because of some very good orders that were received in the quarter.

Looking at the segment’s year-over-year; mining plus 2%, so a sideways development year-over-year, which under the circumstances we see as very positive. The others are then down year-over-year as expected. If we look a little bit on that within quarter trends here, we have seen a continued improve sentiment in mining, metal prices hold up and continued opening up of mines.

In General Engineering; we have seen a recovery more towards the end of the quarter, same with automotive. We should say that both of these we can say that July and August were characterized of more sequential flattish development in the quarter, while the recovery really started to pick up in September. Energy, Construction, Aerospace, we have not really seen any improvement in the quarter sequentially like for the rest.

If we summarize this order intake at minus 11, this would be minus nine excluding major orders in SMT. And revenues follows as also minus 11%. EBIT development very strong SEK 3.5 billion in the quarter and adjusted EBIT margin of 17.3%. This is a leverage of minus 19%, which is very strong for us. Excluding metal prices even better 17.5% versus 18.1%. And as I mentioned, the negative margin development is basically entirely driven by currency effect, while we offset the organic decline through savings initiatives and this is true for all business areas.

If you go into the business areas and start with SMRT; positive order intake at plus 2%. Revenue at minus two. So in both cases are good performances. Equipments had another really strong quarter plus 20%, following a strong performance also in Q2. Aftermarket down minus nine. This is because of a couple of different reasons. First of all, we had very strong compares sequentially quarter versus last quarter Q2; we were up plus 6%. So it shows that activities are going up. On top of that we have some lingering access issues in some mines, so mines have opened up, but they are not allowing visitors if they can avoid it. So non critical maintenance and repair are being pushed out. While we can see that more consumables, rock tools and so on are doing better. We can also see apples-to-apples that specific mining sites that are open, they are actually increasing aftermarket versus prior year.

So underlying sentiment positive and we are not really worried about this, it will come back. Then I also want to focus on another innovation that we also launched a couple of weeks ago, we have launched our first battery operated 18 ton loader. This is the first product coming out of design engineering together between Sandvik and Aritsan, the acquisition we did a couple of years ago. And this is a loader that has been designed from ground up to be battery operated. And also this I think shows the technology leadership we have in this area. SMRT also delivers strong margins, 21% in the quarter, up from prior year also supported by good savings activities. We have also announced the divestiture of our exploration business in October. This is a small part of SMRT. It’s about 1% of sales, so it will not have a major impact. But it was a divestment that we felt was the right thing to do because they had not performed to the level that we expect the Sandvik division to perform.

Then you have also seen the announcement that we are creating a new business area Sandvik Rock Processing Solutions or SRP, effective January 1st. Small note here as part of this, we will also change the name of SMRT to Sandvik Mining Rock Solutions or SMR simply to align with the nomenclature of our other business areas. Going to SMS then a gradual recovery, still minus 19 in order intake and revenues following a little bit behind the minus 21. This is natural in an upswing that orders are leading revenues. Europe on the average sort of say at minus 19; North America 25 negative and Asia minus 15. Here Asia is again, being improved by China. China’s minus one in the quarter. North America versus Europe is also partly driven by higher mix of aerospace in North America versus Europe.

Aerospace, no improvement in the quarter, they are still at the minus 50% level. So that is one offsetting factor to the improvements we have seen in automotive. And in Automotive, we are in the quarter in the low-teens negative numbers. And as I said, the main improvement has really come towards the end of the quarter. Daily order rate in September were in the negative mid-teens. So this shows that in July and August, we really had no improvement compared to how we entered the quarter. But then we saw an uptick in September. This is then continued in October, we are better than mid-teens, but still in the negative double digit range in the first week of October. Despite this very strong margins considering minus 21% on the top line; 18.8% from SMS, strong savings initiative. And in this quarter also, even though they brought down their inventories, they did that last year as well.

So it wasn’t year-over-year, it was neutral impact from the production levels. And I we should also note that the new structure we announced in July is now implemented. So as of October 1st, we have two segments here; Machining Solutions and Manufacturing Solutions, operating as two different business areas segments. Going down into SMT, minus 34% on order intake, and it would have been minus 20 excluding a couple of major orders that we got in August of last year. Obviously, still challenging figures; revenue is a little bit better minus 13%, supported by backlog. Here, continued uncertainty in oil and gas. And also aerospace is obviously soft, but that’s a small part of the SMT business. The positive development in the quarter is that industrial heating or control has started to turn around and they had a positive year-over-year order intake in the quarter. Kanthal is one of our early cycle divisions. And they started the decline over a year ago, and it’s positive to see them now starting to turn around. Hopefully that will also lead to positive development in other businesses going forward.

Despite this drop in top line, SMT delivered a strong margin for them; 4.9% is almost the same level as last year. So very well executed by the team there, good savings impact from them. Then, of course, the big announcement today is that we are proceeding towards preparing them for a separate listing in 2022 if the circumstances are dimmed right then at the time.

With that, I’ll come back at the end, of course, but I’ll now hand over to Tomas for some more numbers.

Tomas Eliasson

Thank you, Stefan. So let’s jump straight into the financial summary. And start in the upper right hand corner, looking at the top line. And as it happens this time, numbers are exactly the same both for orders and for revenues. So minus 11%, as you’ve heard, minus 8% on currency, quite a big number now when the krona is strengthening against the US dollar; structure minus two, which is basically the divestment of Varel Oil and Gas. So all-in-all minus 20% on the top line.

If we then jump into the income statement, further down, earnings came in at SEK 3.5 billion, reduction or declined with 24% or 23%, if you exclude metal prices margin came in at 17.3%. And we’ll dig into the bridge in just a few seconds. Finance net came in at plus SEK 529 million compared to minus SEK 198 million a year ago, a little bit of an odd number, but I’ll spend a half a minute to explain you — explain to you the details in that one as well in a bit. Tax rate 23.6, well within the guided range, strong cash flow SEK 4.9 billion or SEK 10.5 for the nine months, returns 15.5 and it’s not so much the margin it’s more the capital turnover that goes down, now when the top line is decreasing. And earnings per share, adjusted 2.09.

So let’s move to the bridge. And, of course, let’s look at the organic part or price volume productivity. Minus 11% on the top line, that’s SEK 2.8 billion in revenues with an EBIT impact of SEK 500 million, a little bit more than SEK 500 million. That gives us negative leverage of 19%. So basically in line with the margin that we had, so the dilution on the margin is very close to zero, or minus point 1%, basically nothing. If you look at the next column, you see the impact from currency; 8%, that’s SEK 1.7 billion. Also here SEK 0.5 billion in earnings. So this gives 100 bps of margin dilution.

Metal prices takes off 30, structure adds 40. So, all-in-all, as Stefan mentioned here, 100% of the margin dilution in the quarter came from currency. Now, of course, if you look at the fantastic performance here organically, where does it come from? It comes from the savings program, so of course very much. And if we then jump to the Savings Programs slide here. This is what happened in the third quarter. This is the same picture as we had after the second quarter. We have the three programs here; the first one being the savings program that we launched in 2019. It was delivered or executed by mid-2020. But as this is a year-over-year bridge, we will continue to have a year-over-year tail effects in Q4 as well. And a little bit in Q1 before it’s over.

The next two lines are the temporary savings, work time SEK 470 million; it was SEK 605 million in the previous quarter. Other temporary savings, mainly discretionary spending, is executing very, very well delivering very well SEK 630 million. That’s a higher number compared to Q2. But we must also remember that not all of the divisions and the business areas were up and running full speed in these programs on April 1st, it came in a little bit later, some of them in May. In the third quarter, we have been running full speed all three months for all our entities, so a higher number. All-in-all SEK 1.4 billion in the quarter in savings compared to SEK 1.5 billion in the second quarter of this year. And as we have mentioned several times these temporary savings will taper off as the business recovers. Much of it will be gone by year end. But not all of it depends on how we enter 2021.

And we have to replace some of these short-term savings with permanent savings. And you see the numbers in the bottom right hand corner, SEK 1.3 billion in savings already announced in programs during the first half of the year. And depending on how the business develops during the second half of this year, there might be more announcements. So we’ll see.

On the next slide, we have the net financials that plus SEK 529 million. But the real important number here is on the first line is the interest net. That is what’s connected to the debt level and to the interest rates. And that came in at SEK 79 million, compared to SEK 99 million a year ago. We had some maturities at the start of this year. So of course the debt level, the gross debt level goes down. The year-to-date numbering on interest net is now SEK 300 million. And I’ll talk a little bit more about the guidance in a few slides. Then in the middle, you have something called other financial income and costs; in here, we account for the capital gain of the divestment of the 10% stake we had in the Gesac in China. And as this is an associate company and not a consolidated company, you account for the capital gain or the capital loss in the finals net strangely enough, but that’s how it is.

Next slide; tax rate, we report 20.1% but also here the divestment of the 10% stake comes in because this was a Swedish holding. Swedish holding means that it’s tax exempt. So if you add back that the underlying tax rate on our continuing business is 23.6%, well within the guidance range although in the lower half of it. Working capital improved and you can see also on the right hand side that the relative numbers came down for SMRT and for SMS, was increased a bit for SMT. But we should mention here that inventories came down in all three business areas. And speaking of working capital, of course, in recessions or business cycle downturns, you always get a little bit worried about credit losses, or an over due and all that but we can confirm that we have no increase in credit days to our customers. We have actually decreased over dues. And we don’t have any increase in credit losses. So it’s working fine.

Next slide; the cash flow came in strong, as I mentioned SEK 4.9 billion. If you look at the table on the right hand side, of course, if you have less earnings, you have less cash flow, but we continue to release money from working capital and we are reducing CapEx. If you look at the left hand side, you can see that when business declines, cash flow is normally higher than the earnings and you can see it develops exactly like that when business is up like it was in 2017, and 2018, earnings is higher than cash flow. So according to expectations.

My favorite slide, at least for the time being, the net debt development here; cash flow with a strong cash flow, we continue to reduce the net debt, the total net debt is SEK 3.1 billion. But if you look at the financial net debt, it’s actually net cash position of SEK 8 billion right now. And the total gearing is 0.05 continues to go down. Then let’s look a little bit at the guidance we gave you in the previous quarter. We guided for underlying currency effects of SEK 250 million with the weakening of the US dollar, strengthening of the Krona, we came in at SEK 482 million. Total currency effect including all types of revaluations SEK 525 million, metal prices; we guided SEK 50 million came in at SEK 25 million. CapEx SEK 0.6 billion accumulated the SEK 2 billion right now for the year. Interest, as we just talked about SEK 0.1 million and the tax rate 23.6%.

So let’s look at the guidance now for the fourth quarter and the full year. And we did one change two quarters ago, we change the CapEx guidance, we said it’s not going to be 4 anymore; it’s going to be 3.5 in the light of recession, of the downturn in the business cycle. Of course, now with SEK 2 billion for nine months, it’s not going to be SEK 3.5 billion, it will be something less, but well, you have just have to wait for the fourth quarter to see the full year number. Currency, we expect to be minus SEK 350 billion for the fourth quarter; metal prices plus SEK 50 million, interest net minus SEK 500 million is the guidance we have. We are on SEK 300 million now for nine months. So it will be quite a bit below SEK 500 million before the year ends, and the tax rate 23% to 25%. In three months, at the Q4 report, we’ll come back to you and give you a new updated set of guidance for all these items here and also including the tax rate.

So with that, I hand back to you Stefan for summary and conclusions.

Stefan Widing

Thank you, Tomas. Sow we are happy with execution that we have had in the third quarter. The risk of gradual recovery, although it’s a mixed picture across segments. We have continued to show strong earnings resilience throughout this period. We continue to generate good cash flow and we have a strong balance sheet. Looking ahead, we expect the recovery to continue, although market conditions will remain uncertain as long as we are in the middle of a pandemic. And we are right now focused on shifting some of the temporary savings into permanent going into 2021. We are also very happy about the additional announcement that we have done today. We are proceeding towards preparing SMT for a separate listing and that we are creating a new business area, Sandvik Rock Processing Solutions starting January 1st in 2021.

Thank you very much. With that I think we go to Q&A.

Emelie Alm

Yes, thank you, Stefan. Thank you, Tomas. It’s now time for us to start a Q&A session from the conference call. May I please remind you to limit yourself two questions. And if you have further questions, please line up again. So operator, please go ahead.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from the line of Klas Bergelind of Citi.

KlasBergelind

Yes. Hi, Stefan and Tomas. It’s Klas from Citi. So the first one on SMS, if we back out the drag from aero and oil and gas which must be down well over 50% in the quarter then it seems like rest of SMS is may be down 10% and that’s obviously pretty solid improvement compared to the second quarter. And you say October has started down low double digit for total SMS. So what is October doing ex oil and gas? Are we perhaps flat? It sort of looks like it. So I would start there.

StefanWiding

So aerospace, as I said, was down around 50% in Q3. Automotive, as I said in the low teens. The rest were more like in the mid to lower teens as well. So it’s not really 10%. If you do the math on that. Then October, I mean, we have given the information we have that in total we are still in the double digits, but it’s better than the mid-teens. Then there is no reason to assume any difference in terms of the segment mix. So to say, we’re going to continue to see aerospace being tough, while automotive and figures that have come out only recently here as well indicates a continued recovery there.

KlasBergelind

In my mind minus 10, I backed out oil and gas as well. So that must also be down 50% drop.

StefanWiding

No, not really not for SMS, no.

KlasBergelind

Okay. Cool. My second one is on the cost savings for you Tomas. Obviously temporary actions and our run rate SEK 4 billion you did SEK 1 billion in the quarter. And we have SEK 1.3 billion of structural savings to kick in next year. And that’s obviously a pretty big gap to bridge. Of course, work time reduction will not go on forever. But it’s SEK 630 million in other temporary savings or SEK 2.5 billion run rate. How much of this can translate into more structural savings? I’m thinking changed way of working, less travel, more online sales, more meetings with Teams and Zoom and so on. And we have come off the call with Volvo. And they were very clear that they’re not holding on to the savings as much as possible. So I was just curious, Tomas, how much of that other temporary savings can basically translate into perhaps little bit more structural savings at least in the mid term.

TomasEliasson

That’s a little bit difficult to say, of course. But I mean, we don’t believe that travel will come up, come back fully, even in the first quarter of next year. So some of these temporary savings will continue into 2021. And there will be some short-term working weeks as well, depending on which businesses is going into 2021. But of course, we try to learn and we tried to see what we can do more remotely. I mean, we still have to see customers, but maybe some of the administrative work can be done in other way. I don’t know, if you want to comment, Stefan.

StefanWiding

No, I agree. I don’t think we don’t really have a forecast for that. I would say the same thing. We were going to aim to take these learnings and make the best out of it. But it’s very difficult to predict exactly what we can achieve with that.

KlasBergelind

Very quick final one, just a clarification on crushing and screening being separated as an old business area. Do we include mechanical excavation there? Or is that outside?

TomasEliasson

No, mechanical cutting remains in SMR, the other part.

KlasBergelind

And just curious on your market share right now in crushing and screening, Stefan, I mean if could help us. I know you’re leading in terms of margins, at least on the stationary side. But just curious on the relative position in stationary and mobile. If you could give us some indication, it would be very helpful.

StefanWiding

It is a more fragmented market, which is one of the reasons that we are doing this because we think there are also more opportunities. I don’t have a top of my head, a good market share there. So I think we’ll have to refer to IR to come back to you on that.

Operator

Our next question comes from the line of Magnus Kruber of UBS.

MagnusKruber

Hi, Stefan, Tomas. Magnus with UBS. My apologies. I think you mentioned some low teens decline in SMS also, specifically, I mean, first of all is that organic or nominal. And also, I think if we compare that number to the 5% decline in global production or 10% in Europe, it’s a quite big difference. Is there any risk that sort of that difference has been driven by EVs as a larger percentage of the total delivery mix?

StefanWiding

It’s organic to begin with that. So it is currency corrected, so to say, so price volume, the number I mentioned. There is a gap versus production. I mean what we see registration 1.5% in Q3. At least I haven’t seen the final outcome on production. We have seen forecasts minus six up to minus nine, but with maybe the latest data indicating the better part of that. But even without that there is there is a gap. We are not foreseeing that has to do with EVs. We believe it is supply chain driven. Things have turned up towards the end of the quarter. We saw the same thing in March in all factories that shut down and it took two weeks for us to see an impact. I’m not surprised that we see a similar lag in the supply chain when things go upwards. So we don’t foresee this to be in any way a structural difference. It’s a time lag is our view.

MagnusKruber

Got it. Thanks a lot. That’s very clear. Then also on the separation of crushing and screening, could you help us put into context what the margin has been for that business in the past, as well as for the rest of the SMRT business and how should we think about normalized margins for the two respectively?

StefanWiding

You will get more data on the capital markets there. We will share some of this in a much more clear way. What I can say is that they have done a fantastic improvement in the past five years. And it’s now a good business. They’re still dilutive to SMRT, but not materially. And the return on capital is very good. It’s a fairly capital light business actually compared to some of the others. So we will share more exact figures on the capital markets day. So you will have to wait until then.

Operator

Our next question comes from the line of Gustaf Schwerin of Handelsbanken.

GustafSchwerin

Thank you very much, Gustaf Schwerin of Handelsbanken. And I like to start off with the order intake in SMRT had been report any larger orders there for the equipment side, but strong growth. How much of this would you say is some sort of pent-up demand from Q2 and how much is underlying driven by the improvements we’ve seen in metal prices?

StefanWiding

I don’t think there’s any pent-up demand from Q2. We have strong equipment orders also in Q2. Of course, there’s always timing aspects to orders of equipment. But with two straight quarters with good intake, I cannot say anything else that we have a good momentum and it is underlying sentiment is positive, driven by metal prices and CapEx.

GustafSchwerin

Great. And then just following up on the comments you made about the new crushing and screening division. Do you want to say anything whether you view this as core for Sandvik going forward? I saw that you gave the 2019 margin for this; I saw that was slightly below the trough target. So how do you view this going forward?

StefanWiding

Yes, the fact that we turn it into business, I think says that we do believe that this is part of our core business.

And going forward we’ll also share some, again on the Capital Markets Day, some ambitions we have. This will be accretive to our trough margin targets going forward. That’s our ambition.

Operator

Our next question comes from the line of Gael de-Bray of Deutsche Bank.

GaelBray

Yes. Thanks very much and good afternoon, everybody. My first question relates to the processing business. Could you perhaps just elaborate a little bit more on the main differences between processing and the rest of mining in terms of business model? And in particular in terms of competitive dynamics? And do I understand correctly that the main rationale behind the separation of that business is actually to put it in a better position to lead the consolidation process of this specific part of the mining industry. The second question related to SMS. Could you give us some granularity on the respective operational performances of the two business areas, Machine Solutions and Manufacturing Solutions in this quarter?

StefanWiding

So regarding crushing and screening or the new Rock Processing Solutions business area, crushing and screening is what we would characterize as downstream in the process, while the rest of SMRT is upstream. So rock drill, blast and hall or rock excavation, and then we go downstream, we take the extracted rock, and we start to process it to extract the valuable minerals. Those two parts of the value chain are distinct, even in a customer site, it will — we will talk to different people. And the decisions typically are different as well in terms of investments and so on. And if you look at the competitors, I’m not going to name any here, but it’s clearly different competitors in these two areas. They — you could also say that they have a bigger part towards combination. And in that sense construction, so they have a higher mix of construction versus mining, as well. So it’s a clear and fairly straightforward split in that sense.

And I believe with doing this, they will also, drive their own core business and the rest of SMR will drive their core business in the rock excavation part of the value chain. It is a more fragmented part, as I said. There are more opportunities in terms of growth in that area. So that’s what we are going to aim for. Now, when you mentioned, if you want to take a lead in the consolidation of this part, I mean, there is of course, speculation out there; we are not aiming for any big acquisitions in general. That’s not part of our M&A strategy. We prefer bolt-ons, and maybe medium sized. That’s our strategy. That doesn’t rule out any options. You never know what happens, but it’s not part of our core strategy.

In terms of the SMS question, we will comment more as well on that split on the Capital Markets Day. So I want to wait with that. We hadn’t done the split in Q3 yet. So there is no separation in terms of reporting or performance so to say in Q3 between them; they were all part of SMS.

Operator

Our next question comes from the line of Daniela Costa at Goldman Sachs.

DanielaCosta

Hi, thank you very much. And I have two questions. One, which sort of following through, unlike the SMT announcement, you obviously looked at the case over the last few months, and you decided to go ahead with it. Can you explain a little bit why you decided to go ahead with it? And whether and for example, why SMT? And why not sort of a SMRT versus SMS, for example, why do those be together? That’s my first question. And other second question just more on detail or in terms of I think, Tomas said his favorite slide was the one on net debt, and just wondering on capital allocation. What type of level off of — off balance sheet are you comfortable on a more medium term view? I think in the past, you have commented about the ideal potential sort of strategic moves around SMS. So interested on what balance sheet do you think is adequate going forward? Thank you.

StefanWiding

All right. I’ll take the first one. SMT, yeah, when I look into this, I see a business that is world leading. It’s a world leading materials technology company, it’s high performing versus its peers. Within Sandvik, they are always coming in third. And that’s number one, it’s — they are not seen as high performing within Sandvik, which is not a good environment to be in from a people perspective. But also, of course, not from a capital allocation perspective. If we have capital to allocate, I mean, it’s our job to allocate it where it gives the best returns. And I believe from that, that SMT, on its own will get recognition and be able to perform much better as a standalone entity. That’s — those kind of, let’s say, reasons are not valid for any other part of Sandvik. So that’s the reason why we are now decided to do this for SMT. but have no plans or any agenda to do it anywhere else. Tomas?

TomasEliasson

Yes, on the net debt. Yes, of course, we are piling up money in the balance sheet of course. And the leverage is not that high. And it’s not very efficient and it impacts the return; the total return in a negative way. So we need to do something with the money but we are entering a period here now when even more intensified growth agenda, both organically, but also through M&A. So the headroom is big, it’s good. There’s a lot of headroom in the balance sheet now. First of all, we have a strong operational cash flow every year. But we can also use the muscle in the balance sheet and optimal balance sheet. I mean, we said that the gearing, max 0.5, we are in point 0.05 right now. So just do the math on that. So our plan or our base plan, according to our strategy, and our ambitions is to use the balance sheet for acquisitions going forward. If we would completely fail, within the next three, four years, which we will not, but if we would, then we would need to do something else with the money of course; we realized that too, but not now, it’s acquisitions.

Operator

Our next question comes from the line of Max Yates at Credit Suisse.

MaxYates

Thank you. So a quick question on your aftermarket. You talk about having some access issues to certain customers, I presume. Could you give a little bit more detail around sort of where that is exactly what’s happening there? And whether that was something that was sort of more during the start of the quarter and has eased, or whether that’s something that’s been sort of fairly continuous? Thank you.

StefanWiding

Yes. Sure. Now it’s in, I mean it is in specific regions, South America, South Africa, India, for example, it is also in other places, but it’s, it depends on the situation of the pandemic development. And to some extent, also how the history has been and how sort of careful they have become. In — what stopped at the end of Q2 was that mines opened up again, that were closed this with access issues, it has continued throughout the quarter. And I think we will see some of these, it will continue, as long as we have the pandemic situation because obviously everyone is trying to secure their own operations, and minimize the risk and take care of health or safety of people and so on. Of course, it cannot go on forever. At some point, you cannot push out critical maintenance and repair, if you want to continue to operate. But so it’s difficult to say exactly how long it will continue. But it’s not something that we’re just in the beginning of the quarter.

MaxYates

Okay and just my follow up question. If — well, you talked about the automated loader, the battery, the battery powered loader. I mean could you give us a feeling of kind of as we look at your equipment orders this year, is there any way you can give us some details around the proportion of orders, which were from automated equipment? Perhaps sort of any detail around how much it makes up of your installed base, just to give us a sense of kind of how big these businesses are right now within kind of the equipment orders that you’ll take this year?

StefanWiding

Yes, I don’t have a quarterly breakdown on the automation part of the order intake. And I’m not sure if that means a lot either; it comes and goes in batches, so to say, but it is a continued trend. We have said always through this that, yes, this will increase the interest in this because obviously, that’s another argument for automation. If you can also make your operations more secure from a pandemic point of view. But on the other hand, these things take time, it needs, you have to plan for them, when you plan for the design and so on. So we don’t expect the short-term impact on this, but it gives another argument for why this will become interesting mid to long term.

MaxYates

Are you finding you’re selling them primarily to mine sort of fully automated or are you actually selling sort of pieces of equipment just into existing mines that are maybe replacing non automated equipment? And therefore you have sort of interoperable automated and non automated fleets in the same mind.

StefanWiding

It’s much more common that they have automated some machines, some trucks for example or loaders. Fully automated mines are still relatively rare; I would say or they are rare.

Operator

Our next question comes from the line of Andreas Koski at Nordea.

AndreasKoski

Thank you very much. So I can start with a sort of follow up on your cost savings. Because, Tomas, you said that the SEK 1.1 billion that you had in temporary savings will probably fade away by the end of the year. Can you give us some sort of sense of what we should expect for the fourth quarter in terms of temporary savings?

TomasEliasson

When it comes to work time reductions, mainly work time reductions, we guided for SEK 1.5 billion when we started this. And we still believe in SEK 1.5 billion more or less for work type reductions. For the other discretionary spend part; we don’t really have guidance. It depends on the activity level; it depends on traveling very much on traveling. I don’t know if you want to say anything about that.

StefanWiding

Yes. What we can say is that we have businesses now because of recovery that are starting to ramp up marketing and sales activities and so on; travel is still difficult. There are other things you can do. So if anything, it will be less in Q4. But that’s a positive because it means that the business is coming back. So, but then the trade-off of that depends really how things develop during Q4.

AndreasKoski

Okay, understood. And then I would like to come back to Max’s question about the mining aftermarket, because I think in Q2, the mining aftermarket was down 14%. But you said that June or at the end of June at least. I don’t remember exactly, was flat. And then it seems like it deteriorated again in the third quarter. So maybe if you can talk about the profile in the third quarter. Are we still running down like 10% in September in the beginning of October as well for SMRT software market business?

StefanWiding

I think what this speaks to us; I think is how careful we should be to draw trend lines in this environment because it was down a lot in Q2 in the first month. What we can say now is that there was probably a bit of a catch up effect as well in June then. And then we have seen this, it’s not really a ton, but there’s a high single digit decline in Q3. Again, it’s still sequentially up 6%. So it shows that activities have increased actually; we had very high compares last year in as well. So that also needs to be factored in. And also, as I said the consumers, the rock tools that you need to produce, they were flattish. It’s really the wear and tear, so to say, that is down because of these access issues. So that’s sort of the dynamic. And as I said, it’s not that it was only in the beginning of the quarter. I think we will see this during the pandemic, for as long as they can push this out. How long that is? We don’t really know, we will see. But I think the important thing to say is that the underlying sentiment is positive; they are producing. So eventually, they will have to also service our return.

AndreasKoski

And I know we only have two questions, but I just want to check one thing. So we understand you correctly; when you’re saying that your strategy is to do bolt-on acquisitions and no larger deals. Is that true for SMS too? Or are you looking for larger deals in SMS?

StefanWiding

No. So let me clarify what I mean by that. Bolt-ons are at a division. So divisions that do acquisitions and it become might become a business unit or they are brought into the division. When I say medium sized, it is essentially a new division in the group. Divisions in the group are, well, there are exceptions, but let’s say over a SEK 1 billion less than SEK 10 billion in revenue. That’s what I mean with the mid sized; larger than that can happen. I’m not ruling it out. But it’s not part of our strategy because of the risk level and all of those things.

Operator

Next question comes from the line of Olof Larshammar of DNB.

OlofLarshammar

Thank you. Olof Larshammar from DNB. I have two questions from my side. Firstly, it could be interesting to hear a little bit more about the background of divesting this exploration drilling business. And I know that the profitability is riskier compared to the others parts in SMRT, but isn’t this very close to the other products that you are offering? And my second question is relevant SMT and order intake has been a bit below service during the last quarters. And if you could elaborate a little bit about the order between going forward and especially on umbilicals. And if you have seen a trend of customer pushing out what they’re delivered for those products. Thank you very much.

StefanWiding

Right. Thank you. So exploration, yes, let me first say that my first reaction when I came in, so that when the business came and said that they will want it to look at divesting this; this was my first reaction as well, this must be very close to everything else we’re doing. Matter of fact, it is not — it is very specific products, very specific products. And it is also typically not the same people you sell it to exploration and development or production drilling is quite or is separated. So we don’t see any negative impact in that sense on the rest of the business. That said, I’m not saying I wouldn’t regard as a core business, we have decided to divest is now because quite frankly, we did not do a good job a number of years ago, after the financial crisis in the restructuring of that business, and it has suffered ever since. And when we look at it the time and money it would take us to get that into shape. It was not worth it.

While a smaller company that we have now sold it to fully focus on exploration and maybe different expectation on returns. It’s okay for them. I’m not saying that we would never go back into exploration. We don’t see any path to that now. But I’m not saying that this is not something we want to do. But we couldn’t do it in a good way here. So I think this was the best way forward. SMT? Yes, they have been living on backlog for some — since Q2. And it is primarily the longer cycle umbilicals and to some extent aerospace as well. But it’s primarily on the umbilical side. They have some backlog left in Q4 as well, not 100%, but they will also deliver in Q4. We expect a tough 2021. We don’t expect it to be empty, we still get smaller orders. And we still expect to get orders also next year. But it will be low, very low umbilicals here next year. That’s what we are planning for at least when we right size the business.

Operator

Our next question comes from the line of Lars Brorson of Barclays.

LarsBrorson

Thank you. Hi, Stefan. Hi, Thomas, Emily. A couple of quick questions for me, if I can, Stefan. First on SMS in China, I think I heard you say down 1% in Q3 and is down 4% in Q2, we talked about some improvement back in June, July, it looks a bit underwhelming, partly because we’ve seen sort of broader industry data suggest to pick up in that market. Could you help me a little bit with what’s going on in your Chinese business and presumably there’s a greater reliance, some of the larger global accounts, which is your current business might be a slight headwind versus your Dormer Pramet business. But I wanted to just maybe understand a bit better at what you see in terms of the underlying dynamics in China.

StefanWiding

Yes, no, it is to say we, you’re right, I said minus one. And what we see is it’s tough. We have a lot of — a big portion of that business is key accounts or global companies that are also exporting out of China. And that’s been tougher while the domestic market has recovered better. Now fairly big part of our business in China is also in the premium segment. So we are tilting towards the global accounts in that sense as well. So of course, that has an impact on this one.

LarsBrorson

And just as you look into the fourth quarter, do you see any evidence of a more broad based pick up in your Chinese business in SMS?

StefanWiding

I mean, in general, because of automotive coming back more. That also helps because that’s fairly strong in China. That helps. But that’s all we can say right now.

Operator

Our final question comes from the line Joel Spungin of Berenberg.

JoelSpungin

Yes. Good afternoon. Just quickly, I just was wondering if you could just kind of elaborate a little bit on the process of spinning SMT. I don’t wish to seem childish but obviously, you’re saying it could take another 15 months or so. I mean, given the internal separation is complete, I think if you go back a year or two before your time, Stefan, we were talking about having this process completed by the end of 2020. You’re now talking early 2022. Why is it that it’s going to take so long from here and given one of the internal works already been done?

StefanWiding

Yes, I don’t, I cannot comment on what was said in the past, I can say there, even if we would now. And I mean, the internal separation has been progressing as planned with the exception of that there was a quarter delay because of COVID. And it’s now completed. So let’s say we are one quarter behind plan. Even if we will not push this through as quickly as possible, the earliest time we could do it would be at the very end of 2021, probably early 2022. Because when we say internal separation, it’s legal structure, its capital. It’s ERP systems out in the legal entities and so on. But there are still things that need to be done in terms of some generic systems in terms of building the organization, treasury and all of these things that you don’t have, if you don’t have, if you’re not a standalone company yourself.

So the time plan the quickest we can do it is in 15 months, and then it’s or 12 to 15 months. And then when we look at that and say, okay, then we are at the end of the 2021 early 2022. We rather have another quarter or so to be able to execute in a good and efficient way here. And then we are in 2022. And then given where the market is we said, okay, let’s be clear that it is we’re aiming for 2022. It’s not that we are on purpose delaying it, maybe more than a quarter because we simply want to have a more robust time plan. And then of course, we have also said, it has to be right. The right circumstances then, but that is what we’re aiming for. So again, I don’t think we are delaying it much more than the original plan, regardless of what was said.

TomasEliasson

Can I just add, I could just add a few comments on that one? It’s like Stefan said here we have all the businesses in separate legal entities now; we have designed EP systems et cetera. We have operating models for everything. But it’s like you have built a house. But we haven’t moved in yet. Because we don’t want to start to driving double costs until we actually know that that we’re going. So we have a lot of people to recruit in treasury and tax and Investor Relations. And then what have you, we have to commission the ERP systems, et cetera, et cetera. We have to get the engine running, so to say. And that takes a while. Then when we’re up and running, you have to run the business internally with Sandvik as a 100% shareholder or shareholder for two quarters for six months to get clearance from NASDAQ then you can list.

Emelie Alm

Okay. Thank you very much. It’s now time for us to close the call for this time. And we are looking forward to host you again on our virtual Capital Markets Day there on the 3rd November. So thank you all for joining and see you soon.

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