AB SKF (OTCPK:SKFRY) Q2 2022 Earnings Conference Call July 20, 2022 3:00 AM ET

Rickard Gustafson - President and Chief Executive Officer

Niclas Rosenlew - Chief Financial Officer

Patrik Stenberg - Director of SKF Group Investor Relations and Mergers and Acquisitions

Daniela Costa - Goldman Sachs

Andre Kukhnin - Credit Suisse

Hello everyone and welcome to this SKF Q2 2022 Results Call. My name is Nadia and I’ll be coordinating the call today. [Operator Instructions]

I will now hand over to your host, Patrik Stenberg, Director of SKF Group Investor Relations and Mergers & Acquisitions, to begin. Patrik, please go ahead.

Thank you and welcome everyone to this presentation on our Q2 Results. It's a very warm day in Europe, as I'm sure you're aware. As usual, we'll start with the presentation. It will last some 20 minutes. It will be introduced by our CEO, Rickard Gustafson, and followed by Niclas for the financials. After that, we are more than happy to answer your questions. And as the operator stated here, you can post your questions either through voice on the web, or use the chat function and we'll try to answer most of them as we go along.

So with that very brief introduction, I will leave the word to Rickard. Please?

Thank you very much, and good morning everyone and warm welcome to this interim presentation and thank you for joining us this morning. I start by sharing some of the highlights here. And we do close a rather special quarter, with some specific and strong headwinds especially in the month of April and May, then followed by a more normalized June from an earnings point of view. But if I may start with the tailwinds, we saw a maintained and strong demand throughout the quarter, which is very positive. We are constantly watching for, are there any turns towards a more negative economic environment? Do we see a softening demand? But so far, we still struggle to actually keep up with the demand and deliver all as required. So yeah, no real signs but of course, we're preparing for a different scenario.

We do see that in the quarter, we get real price realization coming through in all parts of our business. And I will come back to that as we go through this presentation. I'm also pleased to see that the key mega trends that are sweeping across our societies such as automation, digitalization, electrification, continue to drive strong growth opportunities for SKF. And you will see that also, as we go through this presentation.

When it comes to the headwinds, as I mentioned, they have been specific and severe in this particular quarter. After the war broke out in Ukraine, we have seen a cost inflation and I will touch more about that when we get into on the Industrial side and also the lockdown for all of April and all of May in Shanghai, of course, had a significant impact on our business.

But in terms of our intelligent and clean strategic growth framework, we are satisfied to report strong progress. As you will see today, we see continued good solid double digit growth in most of our focus areas. We are actively now working with our portfolio across all our business areas, and really addressing the low performing parts of our portfolio. We are continuing to deliver on new technology and new products. And in this report today, we're going to zoom in a bit a bid on RecondOil and the RecondOil Box that we just recently launched, that we believe is, have a high potential. And today we also announced a small acquisition of the Italian seals manufacturer Tenute that will complement our industrial offering on the seal side.

And then if you may have seen, we also then have announced some changes to group management. And I want to just briefly comment on those before we go into the numbers. They will not - these changes will not have a negative impact on our ability to drive our strategic framework forward or that we will lose momentum. Now firstly, our Head of China Northeast Asia, Patrick Tong, this is a planned succession. Patrick has decided to retire early fall. We have already secured his successor and he will join at the time when Patrick will actually retire. And we will announce the name of this individual later this year, probably late summer or early fall.

When it comes to Kent Viitanen, who has been the Head of our EMEA region, he has been instrumental in designing this new operating model of ours and he has embedded this now within the EMEA region. He has said that it's time for him to move on and he’d liked to hand over to someone else to take this into the future and really harvest on the opportunities that we see also for EMEA. And I have accepted this and we, to ensure that we keep the momentum, one of the senior member of Kent's team, Aldo Cedrone will step in on an acting basis, while we have already initiated the recruitment process that is ongoing. So we still believe that we have good progress and good momentum in our intelligent and clean growth ambitions.

Now moving on to this quarter, and net sales came in just shy of SEK 24 billion, it's a significant growth in real terms. We're talking north of a 14%, a big chunk of that relates to FX. But the organic growth rate is actually north of 5% which is a solid and sound organic growth rate. In this quarter, it’s not driven - the organic growth is not driven by volume. Volume is actually rather flattish in a quarter so the whole thing is a contribution from our price mix activities.

Our adjusted operating profit came in at SEK 2.5 billion. It's with a relatively low operating margin for the group at 10.5% compared to 15% last year. But I also need to remind everyone that last year is a tough comparison period, probably, Q2 last year was one of the best quarters in the history of the company. But the main drivers behind the relatively low margin in this quarter, all those events that I mentioned previously, the Ukraine war and the COVID lockdown in China and both of them had a significant impact on our earnings primarily in the month of April and May with a more stabilized and normalized earning profile in June.

We estimate that these two events added some SEK 600 million in our cost base in Q2 verses Q1 this year. But we are pleased to report that our ability to get price to compensate for the ongoing cost inflation is actually paying off. We have spent an enormous amount of efforts in really making sure that we compensate for the cost inflation. That work has continued in Q2, we have taken additional pricing actions to compensate for the energy price increases and so forth that was seen in the quarter. And those efforts will also show in our numbers in the months to come.

But to give you a flavor on that we, quarter-by-quarter continue to improve our price compensation, I’d like to refer back to Q4 last year. That quarter, we reported a price mix impact, a positive price mix makes impact of SEK 700 million. In Q1 that number had grown to SEK 1 billion and now in Q2, we report the number of SEK 1.3 billion in positive price mix impact. In the quarter, we have also completed our controlled exit from Russia.

We regret that we had to take that decision to leave Russia but we had no other choice given that the foundation for our business did no longer exist. And we had to take a one-off hit in our numbers in this quarter of SEK 675 million in our result. This is a thing a bit higher than what we anticipated when we announced our controlled exit and we said we anticipated to take a loss of roughly SEK 500 million. The difference SEK 175 million solidly relates to the change in FX with the ruble. The ruble has really strengthened since we announced this previously.

So all-in-all, I think we closed the quarter with solid organic growth. We do demonstrate pricing progress and pricing power in our business and we have managed two exceptionally difficult months in this quarter.

Taking a look into our strategic growth drivers, and I’m happy to report that we continue to see tangible process across all four growth levers. On the high growth segments, as I mentioned before, the key trends - global trends including sustainability is really driving growth opportunities for us. And even though as you can see on this chart, some of the growth rates for some of these industries may be somewhat lower than what we saw in Q1, there are still strong double-digit growth among most of our focus segments. We continue to deliver new technologies and we launched RecondOil Box, as I mentioned before, and we also have signed the first high-volume ceramic bearing contract with the major EV producer. And I will touch more on those two very recently.

In the service and aftermarket, again, we see that sustainability drives significant business opportunities. Many customers, they do strive for more circular solutions, and therefore our remanufacturing capabilities are of high demand and highly interest to many of our customers. And in this quarter we have signed contracts with a steel producer and a cement producer related to remanufacturing.

And portfolio management, as I mentioned, we are constantly pruning our portfolio. We are aggressively looking into opportunities to strengthen our margin and earnings by also exiting low margin business. And you will hear me talk more about that as we go through our Industrial business and our Automotive business.

But let's take a look into the Industrial and starting with the growth. We report a solid organic growth for the entire Industrial segment ramped out business of more than 6%, 6.4% to be exact, as you can see from this chart, strong and healthy growth in the Americas and EMEA, a significant growth in India. To dig a bit deeper on India, of course, there is this very, very strong underlying demand that we have seen in India. But the comparison versus Q2 last year is also a bit skewed. If you recall, India was severely impacted by COVID restrictions at this time last year. So the comparison also boosts the growth rates a bit there.

And then on China, you can see a negative growth there. Again, this really relates to the situation they had in April and May where the Shanghai region was facing a lockdown and we have a significant operation in that region. However, though, we saw a very strong bounce back on the Industrial side in the month of June, not fully to compensate for the weak April and May, but a small negative growth rate then on the - for the total quarter.

Moving into some of the numbers for our Industrial business. And in this quarter, our Industrial business represent north of 70% of our revenues or our sales, and about 95% of our profits. The adjusted operating margin came in just shy of 14% and again, the two main drivers to the relatively low margin is Ukraine and China lockdown. If I may, drill bit deeper onto the Ukraine situation, of course, the bore has caused a significant spike in energy prices, especially in Europe that has impacted us.

We have been forced to double source steel. Some of the steel that we acquired from Russia that we ordered before the war broke out, we couldn't guarantee that we would receive those delivers deliveries because that steel will be transported over the Black Sea by vessels. Therefore, to safeguard our capability to deliver our customers, we have doubled source steel, which has cost us quite significant amount in the quarter. Given the EU sanctions on Russian steel, we had to rebuild our supply chain very, very quickly. And that has also caused some additional pain and cost in the quarter. And constraint logistics has added to the equation.

China, it's somewhat different story, of course than the war. But the close down of Shanghai has really impacted our volumes. But it's important to also explain that this is not just related to China, 40% what we sell in China is being produced elsewhere within the SKF footprint. So this closedown has impacted broadly on SKF and our Industrial business. We do see though, that they've been able to drive broad based price increases in all parts of our business both on the OEM side and the distribution side of our business. And we do see that we have more normalized earnings in June.

We have been working hard on pruning our portfolios. And the way we do that is, of course, that we look into the low margin accounts. And either we try to compensate by price or we are prepared to walk away from that business. We are where we can prioritizing deliveries to the extent possible to have more high-yielding customers. And we're putting new processes and procedures in place to ensure that we don't take in new low margin business onto our portfolio. So all-in-all, I think that it's a rather strong performance to deliver around 14% margin on the Industrial side, given the circumstances. I think the SKF team has done a very, very strong job in a tough situation.

But as I mentioned, sustainability also generates a lot of new customer success stories. And we, as I mentioned before, we manufacture as part of it. But we also see a big demand for rail based transportation, urban transportation, and in this quarter we signed a significant contract with an Italian rail operator, Trenitalia. And one key reason why we win those contracts is also our lubrication capabilities. And this is a rather sizable part of our business that we don't that often talk about. So I wanted to take this opportunity to share some more lights on our Lubrication Management business.

In this space, SKF is a clear market leader and as you can see, we have a rather sizable business, just shy of SEK 6 billion and with a strong and healthy growth. In the first half this year, we have grown this business by 12% compared to the first half of last year, and at Industrial like margins. The business is split in two parts, Automatic Lubrication System, which accounts for up to 75% of our sales and Maintenance and Power Transmission, 25% of sales.

Starting by the Automatic Lubrication Systems, again, sustainability is a key driver here. Green value in lubrication managers is growing in importance and generating more and more customer interests. Combined with our deep knowledge of OEM and end user applications, being a key differentiator in market is really driving growth opportunities for us. And railway is being one example. Here we have won more than 20 metro or public transportation contracts in the last 18 months.

And why do they select us? Why is actually Lubrication Management the key enabler for this? Well, the right lubrication systems helps those customers to increase reliability. It helps them to prolong their service intervals. And it also reduces noise, which is an important key differentiator for many of our customers.

Turning to Maintenance and Power Transmission, it's more a smaller business based more on traditional trading model with a growing e-commerce presence, which is exciting. This is attractive, we sell here at attractive margins and we're eager to continue to develop this business and grow with further it as we move forward. Related to lubrication is also is RecondOil. And I mentioned the RecondOil Box, so let's take a look at the RecondOil Box. This is the product that we launched during the spring. It is a, what I call, a pure plug and play solution for a broad range of segments. As you can see, on this shot, we're talking about marine, pulp and paper, energy, mining, general manufacturing, and so on.

And the key value drivers for customers by applying the RecondOil Box to their manufacturing footprint is first and foremost, to cause to reuse oil and thereby drive down cost. So that's of course a key value driver for them. But to clean oil and to have, very, very clean oil in the production also brings other key benefits. It will increase productivity for our customers by reducing downtime of the manufacturing equipment or provide higher availability within the factories. It will enhance also the end product quality and performance of what's being produced.

And of course, like everybody, like most companies across the globe today, they are all doing what they can to reduce their CO2 footprint. And these solutions also supports in that regard. So far, after launching this, we have received a significant interest in the market. We have sold approximately 400 units today to-date. And even though net sales is still a rounding error in our books, but we do see that this has the potential of a very sizable addressable market, close to SEK 50 billion. So RecondOil is an attractive startup that we have in our portfolio.

Moving onto Automotive. Starting with the growth rate here, and despite a very problematic situation with the closedown in China, we still report a growth, a organic growth rate of close to 3% for the entire Automotive business. As you can see on the bar chart here, America's growth had a nice growth. We also see a magnificent growth in India and Southeast Asia with north of 50% growth. Again, I think we need to reflect that it's a strong underlying growth but also the situation in Q2 last year makes the comparison a bit skewed.

A big negative number in China and Northeast Asia, close to 20%, really there are two drivers behind that. First is of course is they lockdown in April and May, having a significant negative impact on growth rate with a strong bounce back in June also on Automotive. But then we also have a negative comparison or a skewed comparison to Q2 last year on the commercial vehicle side, which was extremely strong in Q2 last year given that after the end of Q2 last year, there was a new emission taxation scheme enforced in China, so people were piling up or buying equipment or vehicles before that new taxation scheme. So comparison levels are a bit skewed here as well.

But looking into the financials or the profitability of our Automotive business, we have an adjusted operating margin of roughly 2% or 1.7%. Same store goes here as it did for - as it relates to Industrial, the Ukraine situation with the energy cost and logistic costs has a significant negative impact in the quarter on our Automotive business. I talked about the Shanghai lockdown but it also brings one other dimension. Normally, we have a somewhat better margin in our Automotive business in China than we have in other parts of our automotive footprint. And therefore, of course, the lockdown in China had a negative impact on the margin mix in the quarter.

We do drive pricing also in this part of our business, aggressively, and we do see that we get priced both on the OEM side and the aftermarket. And when it comes to pruning, I think the team is really staying firm to the strategic direction that we set for our Automotive business to primarily focus on the areas where we have our clear leading positions. And that is, we are the number one in EV, that's where we focus. We already have been the number one player in commercial vehicles, and we're a clear number two in the aftermarket. Other areas, we are now starting to prune and so far, the team has identified sales worth about SEK 1.2 billion that we are about to exit from the portfolio due to that it doesn't really fit into that strategic framework.

We continue to see very, very strong demand for our EV capabilities. And EV, our EV business is growing north of 50%. And that is also reflected in some key wins in the quarter. I'm excited about this, first high volume ceramic bearing contract that we signed with a major global EV producer. And to give you some flavor on this, when we're at full run rate, we’re going sell or this producer will source 2 million pieces of ceramic bearings annually from us. So it's really now a sizable contract and I think a first big inroad into this exciting technology.

And we also signed another important that contract and that is with Volvo Cars for their electric powertrain. And they selected SKF for a number of reasons, of course, from a product, performance, and price perspective. But more importantly, to me, we share the same values as Volvo Cars to really make sure that we have as low CO2 footprint as possible. And there we stood out and could demonstrate that our solutions really helped in the total CO2 footprint for delivering and making the future Volvo Cars. So we're excited about that.

And with those comments, I like to hand over to our CFO, Niclas to give you some more details about the numbers.

Thank you, Rickard, and hello, everyone. Starting off with some details - additional details on sales. So in Q2, as Rickard mentioned, we had a solid sales growth both in absolute terms and in growth terms. And our sales was SEK 23.7 billion in the quarter, the sales grew both sequentially, and year-on-year. And it was actually based on a pretty broad-based demand from multiple industries and across multiple product segments.

As Rickard mentioned, sales was impacted by the pretty exceptional events during the quarter, referring here to our controlled exit from Russia, our operations in Ukraine, where we have roughly 1100 colleagues and our COVID lockdown, not our but the COVID lockdown affecting our operations in China. Compared to last year, our net sales increased by 14.1%, if we go through the bridge here, the impact from the Russian exit was a negative 1.9%. The organic sales increased by 5.4% and the impact of currency was a positive 10.6% with the largest effects coming from the dollar, the renminbi, the Brazilian real, and the euro, so all-in-all, strong sales performance in the quarter.

Moving onto the profit, commenting on the profit. Overall, we had a good momentum as Rickard said in price mix, which was then offset by increasing costs related to the war in Ukraine and China lockdown. The margin was 10.6% and the profit was - the adjusted operating profit was SEK 2,473 million. So if you go through this, step by step, the currency had a positive impact of SEK 241 million. Secondly, the exit from Russia affected the profit negatively by SEK 71 million. The organic growth, on the other hand was positive SEK 259 million and organic here means volume, price and mix. And as Rickard mentioned here earlier, say that all of this gain from price and mix as volume was relatively flat year-on-year.

Also, as Rickard mentioned, we've had good progress in price and mix. So we had in Q4 in rough terms, a year-on-year SEK 700 million, SEK 1 billion in Q1, and then now roughly SEK 1.3 billion in positive contribution from price and mix. On the other hand, we had a quite high impact from the cost inflation, so headwinds from materials, logistics, energy, and also personnel amounting to SEK 2,074 million in the quarter. And to compare, we had a similar effect in Q1 of roughly SEK 1.4 billion. This was driven to a large degree by the exceptional circumstances in the quarter, especially in April and May, referring here to the war in Ukraine and the lockdown in China.

So to sum up, we had a good momentum what comes through sales, price and mix. And then on the other hand, we had a significant increase in cost inflation driven by the war and China lockdown.

Moving on to cash flow, we generated a net operating cash flow of SEK 1,293 million positive in the second quarter compared to SEK 1,372 million last year, so roughly similar levels. We’re actually quite pleased to see that cash flow has improved sequentially. And this is driven by working capital now stabilizing in the quarter. If we look at the bridge between operating profit and cash flow, the non-cash items include the booking we made for exiting Russia. So that's why it's relatively high. While then the other component which also might stick out a bit, include some reductions in product provisions and currency impact related to financial items.

Well it comes to our balance sheet, continues to be strong and also liquidity continues to be strong. We had a net debt amounting to SEK 11.2 billion in the end of the quarter, and we had a solid return on capital employed of 13.7%.

Then turning to the outlook. Looking into the third quarter of 2022, we expect high single-digit organic sales growth, with an expected recovery in Automotive demand compared to Q3 last year. And for the full year, we reiterate our guidance, so unchanged for the full year 2022. We expect an organic sales growth of about 4% to 8%. Saying that, we do foresee that the high level of volatility in the market continues with the war in Ukraine, the inflation, COVID related restrictions, supply chain bottlenecks, as well as volatile demand.

But with that, I hand back to you Rickard.

Thank you, Niclas. And to summarize then, as we have gone through this presentation, we have seen and maintained a solid demand throughout the quarter with organic sales north of 5%. We are constantly monitoring our order intake, trying to see signs for a recession or a setback in different parts of our business. As of now, we have not detected any anything of material - anything like that in a material way. But we are of course preparing the organization to react swiftly if and when such a situation should occur.

As I think we have gone through quite in detail today, we have had a rather exceptionally difficult quarter, where April in May was really negatively impacted by Ukraine and the lockdown in Shanghai. We were pleased to see a more normalized June in terms of profitability in our business.

We are pleased to see that our pricing power remains, we are constantly pushing price, we are not being complacent here. We do understand that we’re still chasing a moving target. We do see that new pockets of inflations are popping up. In this quarter it was primarily energy that was really going through the roof and we have now done a number of things in order to compensate for that, that I hope we will see a positive impact from in the months to come.

But again, I like to reinforce this, sequentially quarter-by-quarter improvement that we do see from price mix, a clear indication that our efforts are actually yielding dividend. And that we do have an ability to over time compensate for the cost inflation that we see around us.

And we're excited and optimistic about our strategic framework. We are confident that we have the capabilities that we have the value add to our customers to really continue to take advantage of the mega trends that I described before, the digitalization, sustainability, electrification, and so forth, to drive profitable growth into the future. So with that, we end the formal presentation part of this session and I hand you back to Patrick to navigate us through the Q&A session.

Thank you, Rickard and Niclas. We are now ready to take on your questions. So with that, I leave the word back to the operator. We'll start with questions over the phone and then we'll continue and follow up with the ones that you've posted on the chat. Please?

Thank you. [Operator Instructions] And our first question today comes from Daniela Costa from Goldman Sachs. Daniela, please go ahead, your line is open.

Hi, good morning. Thanks for taking my questions. I have two, if possible. I wanted to start on your 3Q high single-digit guidance and ask you if you have - if you can give us some color on how much of that is the price realization that you expected versus the volume and on the volume end, is this backed by things that you have, that have been currently ordered and you couldn't deliver? Sort of how sticky you think this is? That's my first question. And then the second question on your point of you see a sequential improvement quarter-on-quarter on the price mix given the price realization, and also I guess steel prices starting to come down, do you think it turns positive already at some point in the end of this year or this is more of a tailwind for 2023? That would be my question. Thank you very much.

Morning, Daniela. And if I may start by trying to address your last question, then maybe Niclas, you can come back to the first one. Well, we do see, as I mentioned, this quarter-over-quarter improvement in price mix. And but with that said, throughout these quarters, you're also seeing a continuously increasing cost inflation. So I feel that we have been chasing a moving target. And the best answer I can give to your question is, if we would assume that we lock in the cost level as it is today, I think it's very likely that we would have been able to catch up before year end. But I don't think that the world will be as static. So time will tell. But the only thing I can promise you is that we will not be complacent. And we will continue to drive price today, to the extent possible to compensate for cost inflation. Niclas?

Yeah, maybe - hi, Daniela, maybe I'll try to elaborate on your first question, so Q3 demand and our high single digit outlook for Q3 for sales. Of course, there's different elements affecting it. I mean, we do - as highlighted, we do continue to be positive about our ability to drive price, then mix is always a bit more difficult to estimate and as we highlighted, we do expect Automotive to have a bit of a bounce back given last Q3 was relatively weak for Automotive. So there's different elements driving it, more positive or we were positive in terms of price. Positive price mix overall, but mix is a bit difficult to quantify, bounce back in Automotive, and then solid underlying demand for Industrial, so overall, is the backbone for our guidance there.

Thank you. Very quickly, sorry, if I've missed this, what was pricing in Q2? And I guess you assume it's higher in Q3 given your price realization comment?

So price mix in the bridge in Q2 was roughly 1300, so SEK 1,300.

That's all your organic is SEK 1.259 billion. It's all price mix?

Yeah, you could say it's all - in round numbers, it's all price mix as the volume was actually in Q2 was relatively flat.

Okay, thank you very much.

Thank you. And our next question comes from a Klas Bergelind of Citi. Klas, please go ahead. Your line is open.

Thank you. Hi, it’s Bergelind Klas at Citi. So first on the cost inflation, the SEK 600 million incremental, just confirm if this was all linked to Russia and China lockdown, i.e. Russia impact and the China lockdown? And i.e. the logistical challenges that might be more temporary or do you also have higher wage inflation and energy cost quarter-on-quarter within that that might stay with us for a while? Effectively what I'm trying to understand is how much of the SEK 600 million that can gradually reverse? And if you could comment, Rickard on the exit margin 10.5% for the quarter, was it perhaps 12% at quarter end? I'll start here, thank you.

Just Klas, clarify. So the SEK 600 million in round terms relates to materials, energy and logistics, not personnel costs. And it's frankly hard to say exactly what relates to China and Russia alone and what's indirect or what maybe outside of those two exceptional circumstances. But we do see that a big chunk of this, if not all, but a big chunk of this relates to these two events, some of it will go away, we saw it already fading away towards the end of the quarter. Some of it such as energy prices in Europe is probably here to stay for longer time.

And again, on your second question, Klas?

Yeah, on the - so on the exit margin, because you said that June had more normalized profitability and you had a very weak April and May. I'm just curious against the 10.5% clean margin for the quarter, what was the margin in June? I don't know if you want to quantify that, but I'll give it a go.

Fair question. But I don't - I am not going to disclose the margins month by month but given that, we say that we come in at a relatively low margin for the group at 10.5%. And we say there are two very weak months, indicates that June was fairly strong. So I think I leave it as such.

Got it. My very quick and final one is on the production, you have the big SEK 170 million boost to EBIT last year because of overproduction, you're still building inventory, but less this time. And it seems like there is a SEK 60 million negative effect to EBIT in the bridge. How should we think about production year-over-year and quarter-and-quarter Niclas into the third quarter given you guidance?

So if I - I mean, if I just elaborate a bit more broadly on production not answering exactly your kind of related to your financials question. But, of course, we've had a strong demand and we haven't been able to fulfill everything. We had strong demand continuing also in Q2, saying that our volumes were relatively unchanged, compared to last year, albeit at a high level. And as commented here earlier, we are prepared for things to turn south if and when that happens. And of course, that we’ll then - we will then have to take actions to make sure that we run the business in a good way, profitable way also in a potential downturn. So that preparedness is there, but I don't know, Patrick, do you want to add some on the - something on the detail?

I might add something there. Yes, I'd say you're absolutely correct Klas. We continue to build some inventory this quarter but less so than last year. So we had actually a somewhat of a headwind in the bridge, about SEK 60 million or so in the quarter. Looking forward, obviously, we were a little bit more forward leaning when it comes to expected growth rates in the third quarter. As you said, we have no ambition per se to continue to build inventories. On the contrary, we usually reduce inventories in the third - in the second half of the year.

Thank you. And our next question comes from Andre Kukhnin of Credit Suisse. Andre, please go ahead. Your line is open.

Good morning. Thank you for taking my questions and thank you for the presentation with all the details and disclosure on the business strategy and price mix. It's great to have that, thank you. I wanted to just come back to the SEK 600 million and trying to split up China versus Russia Ukrainian back there because clearly, one is of more prolonged nature than the other one being a pure one-off. I mean, can you give any indication of whether that's sort of a 50/50, 30/70, like even rough ballpark? And maybe to help us further with that, is it possible to quantify the revenue impact in the quarter from China lockdowns purely from that?

Hi, Andre. Well, I'll try to give you some flavor to this without going into too much details because as Niclas described, those SEK 600 million is an intelligent estimate on our aside how much additional costs we incurred from these events, but it is kind of an estimate. We need to stress that but it did have a significant impact. And of course, the China lockdown was more severe in April and June than was in - sorry, in April and May than it was in June. To give you some sort of flavor, maybe, Ukraine is 6%, China 40% of the SEK 600 million, there or there about but don't take that as a hard fact, but at least maybe as a guiding principle to some extent. And then you had another follow up question that I tend to forget. Sorry, could you Andre, could you help me out here?

Sure, sure. It was just on the revenue impact from, purely from the China lockdowns?

Right. Well, again, I’s like to refer back to the shots I presented, I saw on the Industrial side a somewhat negative growth on the Industrial side in the in the quarter. Of course, we saw a very significant drop in the Industrial sales in April and May, we're talking high double single digit, strong bounce back in June but not fully to recover for April and May. Automotive is more difficult, since there are more kind of disturbing factors there, as I described, Q2 last year. So it's again an extremely strong quarter for commercial vehicles in China, which is basically actually a very, very different scenario at the moment. And it's going to take some time before that recaptures. So again, with Shanghai being a vital automotive region in China, of course, the lockdown in April and May had significant negative impact on growth, and bounced back in June, but a north of 20% drop in April and May from Automotive was definitely something that we saw.

That's really helpful. Thank you. Just -

I’ll just add that, I mean, if you want to - of course, if you want to do some reverse engineering, you could assume that there's no reason why Industrial should have been negative in Q2, while then Automotive shouldn't have been as negative as minus 19%. Exactly what the level or normal level without the lockdown should have been is, of course, very hard to or impossible to say but more positive than these numbers we are showing.

Great. And can I ask, in that guidance for Q3 growth of high single-digit is there any catch up baked into that from the China lockdowns or is it purely just coming back to the normal run rate?

[On that], I’d like to point out there. One is, of course, yes, we do see - think that is a little bit of a bounce back from the lockdown in China. Everything was not bounced back in June, there's more to come. So I think that's part of it. And then as I think, as Niclas described in his presentation as well, clearly also, we believe that it's going to be a somewhat better Automotive quarter in Q3 this year versus Q3 last year, where Automotive had a very problematic situation with a big standstill from the component shortages. So it's a kind of also a rather weak comparison quarter for Automotive or strong if you - depending on which way you want to look at it. So it's the comparison from last year that really drives up the percentage in growth.

Very clear, thank you And last one, if I may, on RecondOil, thank you for the TAM estimates. I guess I have to ask, what kind of market share do you think you can command in this business so in this market with what you're offering? I know it's very early days, but any ballpark or aspiration would be great. And just related to that, I think there was some legal debate, that I one day if there is an update on that?

Yeah. Now the legal debate has been solved since half year back or something. And it was not related to RecondOil Box, it’s more related to our ability to sell some of this technology within Sweden and the rights to the technology in Sweden. But that has been cleared and that is no longer on the table. And it's been as such for at least half a year I think. When it comes to your question about our potential market share ambition and so forth, actually, I’d rather than not disclose this at that stage because it's so new, it is a really a pure startup for us. We’d really treat it as such. We are excited about it. We are excited about the response that we have seen from customers and the market as we have announced the RecondOil Box. We're excited about the simplicity and the plug and play solution that it provides and the value add that it drives. But give us a little bit more time on the belt, a couple of quarters and then I'd be more than happy to share more insights on this because it is a startup and as you know, startups can go in any direction.

Absolutely, I appreciate that. Thank you for your time.

Thank you. And our next question comes from Lars Brorson of Barclays. Lars, please go ahead. Your line is open.

Hi, Rickard, Niclas, Patrick, can I return and apologies for that to the contemplation number, the SEK 2.1 billion, just want to clarify. We're talking about something that's played roughly 50/50 between raw materials and energy and logistics, so a billion each in round numbers in the bridge. Russia, I think you called out Russia, Ukraine at SEK 350 million or so, the 60% of the SEK 600 million, I guess will linger on for some time. I’m trying to understand how to think about your raw material piece as we go into Q3. We've obviously seen quite a lot of volatility, particularly in European steel prices, but a big spike in February/March. I guess, big picture question is, are we past peak cost inflation in Q2? Or do you think that it takes another level up in the third quarter? I appreciate it's an easy year-over-year comp, i.e. there was more cost inflation in the third quarter last year than in the second quarter. But just trying to frame what we're looking at for the third quarter as far as the cost inflation bucket is concerned, please?

It's a really, really good question and, of course, super important component. At the same time it's hard to say, as you know, I mean what - if we just look backwards in time, I mean, what we saw during Q1 was actually a leveling off. And then again, the very unfortunate war, and the lockdown in China, and inflation shot up again. Less so directly from maybe steel prices, but for us, it was about finding alternative sources at the more - the higher price. And then of course, the energy costs shooting up especially in Europe, which then has over time an indirect impact on industries, depending on being dependent on energy prices, so it's a really, really volatile market out there, when it comes to inflation, I would love to be able to say. I mean, you are right, indication that when we look at some raw material prices, we've seen them leveling off and actually starting to come down a bit but then on the other hand, energy prices shooting up and personnel inflation starting to creep through. So it's dynamic and we don't even want to double guess or try to double guess exactly what it will end up being in Q3.

Understood Niclas, if I can finally, if it's difficult to talk about Q3, I guess it's going to be even more difficult to talk about 2023. But I think I've heard you and Rickard say three or four times, we're going to continue to drive price. I guess if I look at your own pricing history, and indeed the history of pricing in the industry, we've had quite prolonged period of price deflation, following spikes and declines in steel prices. So maybe big picture, is there any reason why that will be any different in 2023? I've got a raw material tailwind for you of somewhere in the order of SEK 1.5 billion to SEK 2 billion next year. Now that will be partly offset, of course, by wage inflation and the issue will be ongoing energy price inflation. But I'm trying to understand whether there's anything sort of structurally different as we think about 2023 pricing, from what we've seen in the past? I appreciate it’s far out but curious as to what you're thinking at this stage?

It's very hard to second guess. And we all wish we had the crystal ball to look into, don't we? But I can just reinforce that we have over the last year or so, given that we start to live in this inflationary environment, really stepped up our game in terms of abilities to drive price and abilities to build processes and procedures and tools and how we also motivate and engage our sales force to go out there and actually drive it. I think that's going to continue. I do recognize that we're probably going to see some bounce back in some raw material prices, potentially. But on the other hand, I'm very, very concerned about the energy prices. And at the moment, I see a - my view is rather the glasses are rather half empty rather than half full here, that the - we are in for an interesting winter in Europe, especially of how this will evolve from an energy point of view and what implications that might be for us. So there are things that might go in a positive way, but there are other concerns and dark clouds on the horizon as well.

And of course, Lars, maybe just to add, I mean, eventually, assuming inflation will start to come down from these sorts of levels. And as we continue to work with price and mix also, eventually, it should turn around and become a positive from our perspective, from a profitability perspective. But we are not there yet but eventually we'll get there.

Thank you. And our next question comes from Guillermo Peigneux from UBS. Guillermo please go ahead, your line is open.

Hi, thank you for taking my question. I think it's a follow up actually, from previous question from Lars. And it's, how much of your pricing is driven by value pricing, i.e., basically, what value you add to customers and how much is [discussion] values based on commodities? Because I have the same difficulty, I don't know how SKF will stand in an environment in which you know, would benefit from steel prices going down significantly, and I'm actually passing on price increases, even though I understand that energy prices are going up, maybe your customers will actually see more at the steel, I suppose of the energy in the manufacturing process. So I think my question is going into the pricing next year, how do you sustain this with value pricing, how much of your discussions are value pricing? Thanks.

No, and maybe it may be again, rather than speculating about the future, if you look back at the history of SKF. I mean, we have had positive pricing for many, many, many, many years, not to the same degree that we are talking about now. So you haven't really seen those negative pricing years. If you look back into SKF history, you can of course, speculate what that means for the future but we do see quite a significant pricing power here. And it's, we don't see that the pricing per se, that there should be any structural reason for why it moves up and down with commodity pricing for instance.

Just to follow up on that more, to give you some proof points. Of course, we are really trying to articulate and demonstrate the value that we provide to our customers and charge for that. I went through the lubrication example. For example, I mentioned there the key insights that we have to the applications and the value that we can bring. Of course, that is part of the conversations we have with our customers. I mentioned that we’ve now signed a large volume contract for ceramic bearings. Ceramic bearings provide a unique solution to certain customer problems that we can solve. Of course, we have that as part on the negotiation as we discuss pricing. So it's definitely there and where we can, that's part of the way we interact with our customers. We want to solve problems for our customers, we want to add value for our customers, we want to help our customers reduce their sustainability impact or CO2 impact. And of course, I think that we should have that in mind as we negotiate prices.

And maybe to add here, Patrick just reminded me of the history. So you have to go back more than five years to see declining prices. And that was a very, very different world with an oversupplied market. So again, we don't really see that dynamic. We are, on pricing now as we speak, we need to defend our margins but also work on value with our customers. And for the last five years or so, we haven't really seen declining prices.

Thank you. Being cautious of time, we have one minute to go. So I think we have a couple of outstanding questions online. We will sort them out after that after this call. Andreas and I will take them. But a couple of closing remarks perhaps from Rickard, we have 30 seconds left before we let you go into the summer.

Right. And thank you for your interest and thank you for joining us today. And as I mentioned, just to repeat the summary there, we have had an extraordinary quarter in many ways. Given the circumstances, I think that the team has done a very, very good job in managing this and also keeping our people safe in this environment. We have 1100 people in Ukraine; we have thousands of people being locked into their workspace in China for months. And we have to care for their well being and mental health as well during that this period, and still deliver these numbers. I think that's an acceptable performance.

And we are excited about our ability to see - to drive price. And we are confident that we are in the sweet spot in terms of supporting our customers to help them in their electrification, in their sustainability efforts, in their electrification and digitalization and automation and that would drive growth opportunities, profitable growth opportunities for SKF going forward.

So with that, I thank you so much and wish you all a wonderful summer.