Akzo Nobel NV

AEX:AKZA

Earnings Call Transcript 2019-Q3

[Operator]

Welcome, and thank you for standing by. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this time. May I introduce your speaker for today, Mr. Lloyd Midwinter, Director, Investor Relations and Communications. Please go ahead.

[Lloyd Midwinter, Director of Communications & Investor Relation]

Hello, and welcome to the AkzoNobel investor update for Q3 2019. I'm Lloyd Midwinter, as introduced. Today, our CEO, Thierry Vanlancker; and CFO, Maarten de Vries, will guide you through our results for the quarter. We refer to a presentation which you can follow on screen and download from our website, akzonobel.com.A replay of this call will also be made available. There will be an opportunity to ask questions after the presentation. For additional information, please contact Investor Relations. Before we continue, I would like to remind you about the disclaimer at the back of this presentation. Please note, this applies to the conference call and answers to your questions. I now hand over to Thierry. He starts on Slide 4 of the presentation.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Thank you, Lloyd, and good morning to everyone on the call. At AkzoNobel, we've now reached the midpoint of our journey to 2020 from when we launched it in the third quarter of 2017. And with today's announcement, the results are a proof that we are well on our way. Business return on sales, the number is consistent with our 15% target. Business return on sales increased to 13.8%. This is representing a year-on-year increase for the fifth quarter in a row, and this is up from the 10% at the same time in 2017 when, again, when we announced our Winning together: 15 by 20 strategy. So it shows good progress. Our profit improvement of 23% in the third quarter was strong even though we continue to deal with softer end-market demand. The advances we made during the third quarter were largely due to our ongoing pricing initiatives and cost-saving programs. These delivered 4% price/mix and EUR 19 million cost savings for the quarter. In addition, we announced a new share buyback of EUR 500 million to be completed during the first half of 2020 as a step towards our intended target leverage ratio of 1 to 2x net debt over EBITDA by the end of 2020. We've also announced an interim dividend of EUR 0.41 per share, taking into account the share consolidation conducted earlier in the year.Here at AkzoNobel, we continue to focus on our transformation plans to keep our company on its improved -- improvement trajectory to remain the reference in the paints and coatings industry.Some key financials for the third quarter 2019 are shown on Slide 5. During the third quarter, revenue was up 3% and up 2% in constant currencies. Price/mix was 4% higher, mostly as a result of our pricing initiatives in response to the raw material cost inflation over the years. Adjusted operating income was up 23% for the quarter. And return on sales, excluding allocated (sic) [ unallocated ] corporate center costs, increased to 13.8%. And again, this was mainly due to pricing initiatives and cost-saving programs.The adjusted earnings per share, EPS, was 62% higher. By now we have repurchased EUR 2.2 billion worth of shares by the end of September as part of our EUR 2.5 billion share buyback that has to be completed by the end of this year.Let's now turn to some of the key trends on Slide 6. The impact of both foreign exchange and raw materials moderated during the quarter. And raw material costs are expected to have a moderately favorable impact in the remainder of 2019. Softer end-market demand, including the automotive industry, has impacted our Automotive and Specialty Coatings business and slowed somewhat our growth for Powder Coatings. Demand for Marine and Protective Coatings increased, while revenues remain well below historic levels. Strong growth dynamics continued for aerospace and packaging coatings segments. Demand for Industrial Coatings remained overall subdued. We see a good momentum for Decorative Paints continuing in EMEA and South America, offset by lower volumes in Asia. Going forward, demand trends will obviously differ per region and segment, with generally softer end-market demand in an uncertain macroeconomic environment. So let's move to Slide #7. We are focused on delivering our Winning together: 15 by 20 strategy to ensure that we continue to be recognized as the reference in the paints and coatings industry. Our pricing initiatives, mostly implemented during the first half of the year, continue to deliver with a price/mix of 4% for the third quarter. We are now shifting our focus towards ongoing margin management.We continue to implement our Global Business Services organization and are also steadily moving forward with our ERP integration, having completed 13 out of the 18 go lives that were planned for this year. During the third quarter, we delivered EUR 19 million cost savings and are on track with our transformation plans. In addition, and as yet another proof point, we maintained our gold rating from EcoVadis with an improved score of 75 out of 100, mainly as a result of our efforts in sustainable procurement. We also achieved the top 10 position in the Dow Jones Sustainability Index for our industry despite no longer actively participating.Slide #8 shows the impact of our pricing initiatives, which have now delivered positive price/mix for 7 consecutive quarters. Price/mix for the third quarter 2018 and the third quarter 2019 combined was 10%. Our clear focus on value over volume has resulted in us successfully offsetting the EUR 900 million impact of raw material cost inflation on a run rate basis. This demonstrates our successful strategy and disciplined execution by our organization over the past 2 years. Going forward, we are moving towards ongoing and disciplined margin management across all our categories.Turning to Slide 9. We now have 5 Global Business Service hubs operational around the world. This is a significant achievement and a major change to the way we operate our processes. So far, we have completed 28 country transitions, and 43 transitions are in progress out of a total of 120 to be completed by the end of next year. GBS, or Global Business Services, is a key part of our ongoing transformation and cost-savings program and will provide a stronger foundation for our organization in and beyond 2020.Slide #10 shows the results of our Winning together: 15 by 20 strategy in the cost-saving programs. In 2018, we complement -- completed, sorry, the first phase of our transformation and fully delivered that year on the EUR 110 million planned cost savings. We delivered EUR 19 million cost savings in the third quarter 2019 and EUR 100 million year-to-date, including around EUR 30 million carryover from last year in Q1 and Q2 2019. We are on track to deliver the previously announced EUR 200 million cost savings by 2020. And although, as previously already indicated, this will not be a straight line over the quarters due to the timing of the activities and their relative cost and benefits, we are very confident on doing so.Slide 11 illustrates just one example on how we are focused on continuing to develop our organization. Our Extended Leadership Team, which consists of all the direct reports into the Executive Committee totaling around 50 people, has continued to evolve and be renewed during the recent years. In practice, this means that over half of the ELT, the Extended Leadership Team, have joined within the last 2 years, with roughly half of those new people joining through internal promotion, demonstrating our focus on internal succession planning.Slide #12 shows our transformation plans as we presented them in March 2018 and the work streams set to contribute most to our cost savings for 2020. Sales force effectiveness is on track with changes to the organizational structure and now working toward standardizing end-to-end processes, including implementing one CRM system. Our R&D organization's structure has also been optimized as part of our focus on innovation excellence and is now collaborating with procurement to deliver on opportunities from value engineering.Implementation of our GBS organization, our Global Business Services, as discussed earlier, is an important contributor to cost savings for next year. Our ongoing ERP consolidation will be a key future enabler for our performance and cost savings. Although our footprint optimization is a very important part of our strategy, we have taken the conscious decision to derisk the implementation. Our footprint optimization plans will deliver further cost savings in the future. Creating a high-performance culture, including improvements to show -- to how we measure and manage performance, remains a key focus area for 2020 and the continued transformation of the company. We are making very good progress and continue to focus on delivering our transformation plans. These results are a testament to the great work of the entire organization around the globe at AkzoNobel. And with that, I now hand it over to Maarten, who will run through the detailed financial results as of Slide 14 and onwards.

[Maarten Jan de Vries, CFO & Member of Management Board]

Thank you, Thierry, and good morning, everybody, on the call today. A quick recap of our financial results for the third quarter is shown on Slide 14. Revenue was up 3% with positive price/mix offset by lower volumes. Volumes were lower due to softer market demands, including the automotive industry, similar to what other players have experienced. Our focus on value over volume delivered 4% price/mix. Adjusted operating income was 23% higher at EUR 300 million, driven by pricing initiatives and cost-saving programs. Return on sales, excluding unallocated costs, increased to 13.8% versus the 12.3% as reported in the third quarter of 2018. Operating income included negative identified items of EUR 53 million mainly related to transformation cost and noncash impairments in Performance Coatings following the implementation of our strategic portfolio review.Moving on to Slide 15. We've delivered positive price/mix for 7 quarters in a row and cumulatively 10% in the third quarter of 2018 and the third quarter of 2019 combined. Decorative Paints price/mix was 5% higher in the third quarter while volumes were 5% lower due to strong performance in EMEA and South America more than offset by lower volumes in Asia. Volumes were lower in China, although the impact was less than previous quarters, and volumes grew for the premium segment in China.Positive price/mix of 3% for Performance Coatings was offset by 3% lower volumes due to softer end-market demand, including the automotive industry.Slide 16 shows the development of adjusted operating income during the third quarter 2019 compared to 2018. Foreign exchange rate had a slightly positive effect, and pricing initiatives resulted in EUR 95 million from positive price/mix, partly offset by lower volumes. The effect of raw material and other variable cost moderated and were roughly flat for the quarter. And continuous improvement continue to offset wage and other fixed cost inflation, which, together with our transformation plans, delivered a total of EUR 19 million cost savings during the third quarter. Several one-off items have impacted the year-on-year comparison, including some positive items from asset network optimization in the third quarter of 2018 and some additional costs associated with the transition service level agreements for our former Specialty Chemicals business in the third quarter of 2019.Next slide, the Q3 results for Decorative Paints. Revenue was up 3% and up 2% in constant currencies. Acquisitions contributed 2%. Decorative Paints improved profitability in all regions. During the quarter, we launched Dulux Trade Evolve. This revolutionary paint is made from 35% recycled paint that meets the same high standards expected from Dulux Trade. Adjusted operating income increased to EUR 135 million, up 17% versus last year. And the continued pricing initiatives and cost savings more than offset lower volumes, resulting in higher return on sales of 13.8% versus 12.1% in 2018. Moving now to Performance Coatings on Slide 18. Revenue was up in all businesses, except for Automotive and Specialty Coatings due to softer end-market demand. Automotive and Specialty Coatings was impacted by a reduced demand from the automotive industry, while demand for aerospace coatings remained strong. Positive price/mix in Powder Coatings was partly offset by lower volumes, including for the automotive industry. Profitability of Marine and Protective Coatings continued to improve due to measures focused on restructuring and rightsizing, particularly in Marine Coatings. Focus on value over volume in Industrial Coatings resulted in positive price/mix, partly offset by lower volumes, while demand for packaging coatings remained strong. Adjusted operating income for Performance Coatings was up 14% at EUR 194 million as pricing initiatives and cost savings more than offset lower volumes. Return on sales was up at 13.7% versus 12.2% last year. And the operating income was adversely impacted by EUR 38 million of identified items, mainly related to the transformation and noncash impairments in Industrial Coatings.Now turning to Slide 19. In the third quarter, adjusted earnings per share from continuing operations was 62% higher at EUR 0.97. Profit from continuing operations increased to EUR 175 million in the third quarter versus EUR 155 million last year. Adjusted earnings per share also increased due to the positive impact from fewer shares following the capital repayment and share consolidation earlier during the year as well as the ongoing share buyback program. Moving to Slide 20. Net cash from operating activities resulted in an inflow of EUR 312 million during the third quarter versus EUR 284 million in 2018. This increase was mainly driven by higher EBITDA for the period. At September 30, 2019, net debt was at EUR 537 million versus negative EUR 5.8 billion at year-end 2018. This development was mainly due to the return of proceeds following the sale of Specialty Chemicals business.Slide 21. We announced an interim dividend of EUR 0.41 per share. Our dividend policy remains to pay a stable to rising dividend, and our dividend is paid in cash. I'll now hand back to Thierry for concluding remarks on Slide 23.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Thank you, Maarten. In conclusion, we are very pleased with the continued progress towards our strategy demonstrated by today's result. As indicated before, we've now reached in time the midpoint on our journey to 2020, and we are certainly well on our way with adjusted operating income 23% higher and a ROS up at 13.8% for our businesses. This morning, we also announced a new share buyback program of EUR 500 million as well as an interim dividend of EUR 0.41 per share. We continue to focus on our plans for the future to ensure AkzoNobel remains the reference in the paints and coatings industry.Finally, turning to Slide 24, which shows our updated outlook. We are delivering towards our Winning together: 15 by 20 strategy and continue at full speed creating a fit-for-purpose organization for a focused paints and coatings company, contributing to the achievement of our 2020 guidance.Demand trends differ per region and segment in an uncertain macroeconomic environment. Raw material inflation is expected to have favorable effect in the remainder of 2019. Continued pricing initiatives and cost-saving programs are in place and on track to address the current challenges. We continue executing our transformation to deliver the previously announced EUR 200 million cost savings by 2020, incurring one-off costs in 2019 and 2020.We target a leverage ratio of between 1 and 2x net debt over EBITDA by the end of 2020 and commit to retain a strong investment-grade credit rating.With that, I hand it over to Lloyd for information about upcoming events and to start the Q&A session.

[Lloyd Midwinter, Director of Communications & Investor Relation]

Thank you, Thierry. Before we start the Q&A session, I would like to draw your attention to some upcoming events shown on Slide 25. The ex-dividend date for our 2019 interim dividend is on October 25 and the record date is October 28, followed by the payment on November 6. We will publish our report for the full year and fourth quarter on February 12, 2020.This concludes the formal presentation, and we would now be happy to receive your questions. [Operator Instructions] Operator, please start the Q&A session.

[Operator]

[Operator Instructions] Our first question comes from Mr. Charlie Webb from Morgan Stanley.

[Charles L. Webb, Equity Analyst]

So my 2 questions. Firstly, just around raw materials. This is the first quarter you now kind of cited tailwinds into Q4. Perhaps you can help us kind of gauge the scale of that raw material deflation in terms of what positive it brings to the EBITDA line or EBIT line. And then also thinking about 2020, how big mark-to-market does that raw material tailwind look like today? And then secondly, just on the volumes. As we think about decorative in particular, how much of the volume loss in the quarter was from volumes that you walked away versus underlying market weakness? And perhaps at what point should we start to see volumes turn more positive given your lapping, easier comps?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. Good question. Let me do the volume one and then Maarten can enlighten you on the raw materials for that. On the volume, I think you specifically asked it for decorative, if you -- I'll take the liberty to go maybe a little bit broader on that.On Decorative Paints, if you look around the world, frankly, volume changes are irrelevant for all regions, except for Asia. So in that sense, I think it's pretty local. Now also there, as we've indicated in some of these places year-over-year, we walked away from lower-end putties, lower-end paint, et cetera, that will start to stabilize. It is, in fact, very encouraging to see that our volumes in, for example, in China in Dulux paint has actually gone up year-over-year. So it shows that the strategy is working for our really margin-bringing part of our portfolio. So there, we actually are doing quite well. So I think this is more a temporary moment. Let me then go to Performance Coatings. Performance Coatings is at a minus 3% year-over-year. To be honest, that has really nothing to do with actions that we might or might not have taken. What we see is actually about the market. You may remember that we've indicated that of the volume losses in the earlier part of the year, that it was about 1/3 to market, 1/3 our actions and then 1/3 was actually regretted losses. I would say those 2 other categories basically are now done. So what you see is, I would say, the underlying demand in our markets where we hold our own very much, but that reflects what the markets are. So I think for the fourth quarter on volumes and for next year, fourth quarter, we will probably see something similar in volume because we know when we stepped out of some of these markets earlier and then basically almost go to a year-over-year flat volume for 2020 versus 2019. We did indicate in our briefing earlier that we are pivoting away from the value over volume almost "no matter what" to really going to a disciplined margin management because we have now caught up with the raw material inflation over that period of time and we went back to beginning of -- end of 2016, really, on what we wanted to recover.So on volumes, you'll see a similar trend quarter-over-quarter in the fourth quarter. In 2020, it should be a flat situation. But we do see in Asia, for deco specifically, we see for our Dulux paint actually an uptick, which is extremely promising.On the ROS, Maarten, maybe you want to go in more detail?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. So on raw material, yes, first of all, you've seen until mid this year the runup of the total EUR 900 million of raw material over the periods 2017, 2018 and the first half of 2019, which was still EUR 110 million. And it was, of course, the first half, EUR 110 million was very much on the back of the high raw material position by the end of 2018. We've also indicated that post the peak of the end of 2018, raw material started to soften a little bit.Now this is exactly what we've seen now in the third quarter where quarter-on-quarter, we see it more or less flat. That's also what we have indicated. And then mathematically, if you take that going forward into the fourth quarter, you see an unfavorable effect in the fourth quarter quarter-on-quarter versus the fourth quarter of 2018. And I think going forward, you could also take that as a proxy for 2020. It's for us, obviously, difficult to predict. And our kind of 15 by 20 strategy is really based on our own actions we take and not banking on a tailwind of the raw material situation.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Did that answer your question, Charlie?

[Charles L. Webb, Equity Analyst]

Just perhaps on the raw material one, is there any sense you can -- or can you give us any sense of the scale or the magnitude that we should expect from where you see the raw material basket today? And then perhaps also as you talked about that kind of margin management, does that mean that you will give back pricing to your customers at all given this deflation or was that not the case?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

No. So in fact, on the margin management, we know that we've been very disciplined in keeping the hard line around. We have to get our prices up given what the raw materials are doing. Now what Maarten explained around raws, it's not exactly like they're coming down to the good old days before. There is a soft deflation on raws.What we did say though with what we see is that we want to go to a disciplined margin management. In fact, in the third quarter, we already pivoted in some of our segments to that point, where we really want to drive our contribution margin and drive it still up, to be honest. But that's much more in line with what markets can accept where we feel our brand or distribution strength is strong, where our technology is strong, so it becomes a very methodical margin management versus the get-your-prices-up mantra that we had in our organization. So far, I think that's a healthy development. I would say it's the GPS moment, you have arrived on the pricing work and now it becomes a margin management.Maarten, if you want to talk about raws?

[Maarten Jan de Vries, CFO & Member of Management Board]

No, I think -- I mean we shared our views and we constantly, I mean, are tracking how this will develop. But there is no -- I mean it would be wrong for us to make a certain forecast at this moment.

[Operator]

Our next question comes from Mr. Tony Jones from Redburn.

[Tony Jones, Partner of Chemicals Research]

Tony Jones from Redburn in London. I've got 2. First one, on the cost savings in the bridge, for Q3, a little bit lower than we were expecting, and I appreciate that the net gains per quarter could be lumpy, as you called out earlier. But maybe you could give a little bit of an indication on the magnitude and phasing of it in the next few quarters. Or is it going to be more back-end loaded towards the second half of next year? And then a question on the buyback. Good news that was announced today. But what should our interpretation be both in terms of the magnitude and also the duration?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

So Tony, thanks for your question. Let me maybe talk about the buyback and then have Maarten talk about the cost savings. That's the way we split it up. I do the fun stuff and he does the other stuff.On the buyback, the reason why we announced it, first of all, the buyback on the EUR 2.5 billion that we want to -- that is currently ongoing and which is returning the proceeds of Specialty Chemicals, that's totally on track. It is, of course, at an arm's length handled by a third party who, frankly, decide themselves when and how they're going to buy, and that can be a lot in a week or it can be nothing in a week, depending on how they decided.So as that is coming to an end somewhere in the next months or so, we felt, if we look at our numbers, to go to our intended leverage of 1 to 2x debt over EBITDA, that yes, we -- it's logical given what we have on our agenda and where we want to get in 2020 that there is additional share buyback. We've probably done it in a slightly different way. So the EUR 0.5 billion for basically 0.5 year, to kind of summarize it a little bit, is kind of a modular approach, which is kind of returning. And I think we've been very clear on that from the very beginning, we will get to that leverage in the most shareholder value-adding way. That means at this moment of time, we believe the share buyback or an additional share buyback is the right moment to do. At one moment of time, that might be a bolt-on acquisition, so we just want to keep our powder dry on how we want to do this. So you almost have to see there's an ongoing, I would almost say default position, if I may say it like that, of share buybacks. And that's why we want to do it more in a 0.5-year rhythm to return shares -- to buy back shares.Does that answer your question, Tony, on the first part?

[Tony Jones, Partner of Chemicals Research]

It does. Yes. So -- and maybe just sort of tied in with Axalta, are you sort of absolutely ruling out that that's a potential target?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Well, I think those things are disconnected. But I think we've been pretty clear that we are not in a process. We said that a number of weeks ago when there were questions and rumors flying around. We're not in a process or in a discussion, and that continues to be the case today.On the other part, Maarten?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. So Tony, so we have announced a EUR 200 million program -- a EUR 200 million cost-saving program over 2019 and 2020 to deliver and support the 15 by 20 targets. This year, in the first 3 quarters, we have delivered EUR 100 million of cost savings, but it includes and we have also indicated that roughly EUR 30 million of carryover of the cost-saving program of last year. So out of the EUR 200 million (sic) [ EUR 100 million ] is EUR 70 million in the first 3 quarters. And your observation is absolutely right. The EUR 19 million -- I mean these cost savings are not linear. The EUR 19 million in the third quarter is a little bit lower, as you would expect, and that is related to transitions where we go through worker council consultation process. In this case, we had some shift in time lines, specifically in some European countries. In this case, I can mention for instance, Spain. That's one.But on the other hand, the third quarter, and you've seen it also in the whole ERP rollout, has been pretty massive in the number of ERP implementations. And that is, of course, also a cost you take before you reap the benefits. So it is here and there a timing thing. It's not linear. But we are managing overall this total EUR 200 million program, and we've said that is approximately EUR 100 million this year and approximately EUR 100 million next year. But total, it needs to deliver the EUR 200 million. Does it help?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. I would also like to add to that, Maarten, that on the Global Business Services, you've seen that we're making very fast progress on that. But frankly, you have to start that up first before you can actually take the measures in the rest of the organization. So that's actually why we've been signaling from very early on, this was not going to be a linear line because of the puts and takes you have in a specific quarter. Does that answer your question, Tony?

[Tony Jones, Partner of Chemicals Research]

It does, yes. Very helpful.

[Operator]

Our next question comes from Mr. Peter Clark from Societe Generale.

[Peter Anthony John Clark, Senior Analyst, Chemicals]

First question, just on the EMEA deco where your volumes were slightly down, I think, like they were in Q2. Have you got any comment on the U.K.? Because obviously, one of your peers was mentioning that less some sort of Brexit effect moderating the market. I know Q3 particularly is seasonally a very strong quarter in the U.K., so at least it's done. And then the second question, just on the auto side, you mentioned obviously the drag effect of that. Just wondering on the refinish side of that, how the business is relative to -- I know we've had some pretty up and down quarters, partly destocking of major customers, soft demand, just where your business sat in Q3 with that one?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. Okay, Peter, thanks for your question. On deco EMEA, that business continues to do quite well in general. So I think that's good. As you know, we are by far the #1 in Europe, Middle East, Africa and that's -- actually that position, if anything, is strengthening as we speak. Specifically to the U.K., the business is doing quite well. But of course, the -- in the third quarter, it's typically the September month that's important. And I wouldn't over-interpret too much because it's sometimes the last week and the cutoff dates, et cetera, that make a difference there because it is such a high ramp-up at the very end of the third quarter. The third quarter in the U.K. was actually okay in volumes, so there was nothing specifically to announce there. The Brexit effect, not sure if we see a big impact of that. We've seen the pound, we've seen consumer confidence, but that's been over the last 2 years. So I don't think there was anything specific to mention on the Brexit side as such. And it continues to be a very strong pillar in our European deco business and that hasn't changed at all. Secondly, on the auto side. As you know, to automotive itself, we have a relatively low exposure. That is high single digits for the company in total, sits about half of that in our automotive Specialty Coating business unit and the other half sits in Powder. Powder is growing in volume despite that automotive part being down, so that shows a pretty positive dynamic for Powder.On refinish, very specifically that you asked, the refinish business in the third quarter wasn't very strong. And we've seen, of course, as you might imagine, we've been bird-dogging the announcements of others so far, and it looks like everybody has about the same phenomenon on refinish. That also goes sometimes a bit lumpy, so I'm not sure if we are ready to draw any conclusions on that so far.Does that answer your question?

[Peter Anthony John Clark, Senior Analyst, Chemicals]

Yes, that's fine. And your pipeline, I suppose, M&A pipeline, you're still quite rich obviously from your comments before, healthy?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

On the M&A pipeline, absolutely. So there, we continue to be focused on bolt-ons -- bolt-on acquisitions. So that continues to be healthy. Again, the only awkward thing with bolt-on acquisitions is that it's smaller companies, sometimes privately held, so the timing is a bit less easy to forecast, but the pipeline is pretty healthy and actionable from our perspective.

[Operator]

Our next question comes from Laurent Favre from Exane.

[Laurent Guy Favre, Research Analyst]

I think this might be me. Laurent Favre from Exane. Two questions, please. The first one, Thierry, you talked about EUR 900 million of accumulated cost inflation and around 10% price increase. So it sounds like you're about even at an overall level. Could you maybe give us some comments on if there are some regions or business lines where you are -- you still have work to do on pricing and where you haven't caught up on your gross margin targets? First question. And then the second question, maybe for Maarten, on corporate costs. Can you give us a guidance for 2019, but also more generally on what you target, especially after all the work done on business services?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. Laurent, thank you for your question. By the way, this should be an incentive for changing your name to John. It would be much easier for these kind of calls to recognize how you get introduced, okay? First of all...

[Laurent Guy Favre, Research Analyst]

[ We'll try Larry ].

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Well, that's another option. On the EUR 900 million raw costs, yes, raw material costs and then the 10% price, you are right, I mean, so that's what I meant with the -- in the real, the brutal force on getting our prices in line, I think that work has been done. So I think we're there. Hence, why we move to disciplined margin management and margin expansion management, I would say, in a different way across the portfolio. If you look at businesses across the board, honestly, I mean we don't publicize that. But if you look at our 8 business units we look at, it is across the board, very impressive work. So there is no business that is left behind on that and has done the work. A shout-out, I would say, is for our South America organization in deco who's done dramatic work because they also had to offset currency and really very weak currency situations. So that is probably, on the one side, a very, very strong performer. And I would say also on the deco side, if you look at China, not an easy environment, not exactly a market that is often very open for pricing moves. But also there, I have to say, the management has done it in a very disciplined way, focused on continuing to strengthen our premium side, even volume-wise to strengthen our premium side. So that's been very positive. And in Performance Coatings, in fact, all of the businesses, and we keep tracking them almost at a neurotic level, all of these businesses have done the work. So in that sense, all of the businesses in the third quarter were firmly in double digits on return on sales, which is actually a very good performance. So in that sense, I think it's across the board, Laurent.Does that answer your first question?

[Laurent Guy Favre, Research Analyst]

Yes, it does.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Okay. And Maarten?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. Laurent, on your second question on corporate costs, as you know, we have indicated a range of EUR 140 million to EUR 180 million on the corporate and allocated costs. For this year, we have earlier indicated that we will be at the bottom of that range, yes, and that means that likely for the fourth quarter, we will see a bit higher level versus what we've seen in the first 3 quarters. We have also seen in the first 3 quarters, even there are some positive incidentals in these numbers, which has helped these numbers every quarter a little bit. And for next year, again, we sit in the range of EUR 140 million to EUR 180 million where I would take for the moment the midpoint as the proxy.Does that answer your question?

[Laurent Guy Favre, Research Analyst]

Yes.

[Operator]

Our next question comes from Mr. Laurence Alexander from Jefferies.

[Laurence Alexander, VP & Equity Research Analyst]

Could you flesh out -- there was a comment in your prepared remarks about how some of the productivity projects, if I heard properly, had been dialed back to derisk them. Can you flesh out what that implies for productivity opportunities longer term? And secondly, on the margin -- disciplined margin management strategy, how will you be thinking about bottom slicing going forward? Is it more of a pro-cyclical or contracyclical activity?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Okay. On your first question around what we derisk, I mean that was not exactly a new statement. I think we've said that before that on our -- specifically on our manufacturing network, that we wanted to derisk it. There's so many things we're working on, that we really wanted to do this in a very deliberate way, but that was an adjustment we made relatively early in the program. So therefore, some of the benefits from that specific program that we're going to land in 2020 will indeed land in 2021. Now by the way, there's a number of programs where -- that will not be finalized by 2020. And in fact, some of them are only just starting to ramp up. If you look at our value engineering, for example, exercise, that actually will deliver much more in '21, '22. So just answering that, I mean, we've been compensating that with other programs that actually are ahead of plan. So that's why we feel confident on the track that we have also for 2020, but there's obviously much more beyond. So in fact, beyond 2020, and I think we said it in different public fora, the 2020, the 15 by 20 is kind of an internal health fitness exercise. But it's really on the way to deliver much more in '20, '21, '22, '23 because a number of these programs are just ramping up, given the complexity and the sheer amount of SKUs, the sheer amount of materials and sites involved in that. So that's on the one side. So there's definitely much more value expansion beyond that. And we will probably elaborate on that a bit more early 2020 because then I think we owe it to start giving a view on what's happening beyond 2020.On the bottom slicing, not sure if I understand the question, but let me go around the margin management. Given the unprecedented, across-the-board raw material increases since the end of 2016, it was really get our house in order and get our prices up. I think that was done in a very disciplined way with 144 performance cells. So where do we have to go? Where do we have exposure? And what should we be doing? As we just elaborated, we've offset this EUR 900 million raw material increases. We've offset that now by price. So we basically are back on where we should be. That was, by the way, an assumption when we launched our 15 by 20 that we would have the margins under control. When you talk about bottom slicing, indeed, what we would be doing right now is going much more, and that has started already on a business by business, looking at what is the margin development, what is the strength of the portfolio. So I would say that bottom slicing is probably not the right word for it. It's a constant portfolio and margin view and margin expansion view that we'll be taking across our businesses.Does that answer your question?

[Laurence Alexander, VP & Equity Research Analyst]

I guess. Just maybe, if this bogs down, we can take it off-line. I guess just wanted to flesh out, as you think about bottom slicing opportunities going forward, should we expect more bottom slicing in a softer environment? Or would you take a conscious cyclical strategy of trying to be pruning the portfolio more when things are healthier to try and optimize the real value add as opposed to just a cyclical leverage?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Well, I would almost say it's probably going -- we have pretty good visibility now on what our ROS and what our costs are going to be 6 months, 9 months out. With that, I think that allows us to do the margin management proactively, knowing where our costing -- variable costs and fixed costs is going to be. So I think that's probably more how we're going to handle it versus reacting when we are in a crisis. Not now.Just one correction I would like to make. Given what we've been doing over the last 18 months to 2 years, the bottom slicing, as such, is more or less done. There were some really parts of the portfolio that we thought were unacceptable in performance and we had to do something. So if you look at our volumes just now, as I indicated, it is actually reflecting the market. For Performance Coatings, I think we are -- actually, it's maybe slightly better than market. But -- so that's -- so the bottom slicing, as such, has come to an end already.

[Operator]

Our next question is from Mr. Chetan Udeshi from JPMorgan.

[Chetan Udeshi, Research Analyst]

Just on that other line in the bridge. Just to understand because there are some certain moving parts from time to time which some of them are one-off or not, it's always difficult. But maybe if you can just split the positives and negatives in Q3, that will be helpful in terms of quantum. And also just going back in that other line on the bridge, that number has been quite a bit variable in terms of magnitude. I remember, if I'm not wrong, in 2017, it was a positive EUR 180 million or EUR 190 million. So is there a way to move some of these one-offs maybe as part of EBIT and not adjusted EBIT so we don't have these ups and downs? And the second question was on -- in the price versus mix calculation for Q3, you mentioned the deco volume's down in Asia. Did that have any benefit on the mix part of price/mix? Or was it only price in Q3? Sorry, Q3, yes.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Okay. Maybe let me take the last part and then, Maarten, you can take the first part. In Asia, this is, again, this is the effect of -- well, in China, this has been indeed the portfolio management, as we indicated, with lower-end putties, et cetera, where I think the team did very disciplined work. So that would probably be more in the mix version of things for what China is concerned. For Southeast Asia, there's a combination of some of our key countries of weather, but it's also in some cases some distribution changes we did, which frankly are neither price or mix. It just shows volume because then you have a timing issue between what our inventories in the channel, et cetera. So in that sense, I mean it has a minor impact in those numbers. I don't know, Maarten, on the first part, if you...

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. On your first question on the other parts in the bridge. Now first of all, I want to say that what we're doing is we're trying to be extremely transparent how our EBIT bridge has built up from a margin perspective and the factors impacting the margin, so including volumes, price/mix, raw material as well as how we're advising the OpEx savings. And yes, there are sometimes some pluses and minuses impacting the last quarter. We had clearly a big negative indeed in 2017, which we separated in the second quarter of -- sorry, in 2018, which we separated in the second quarter of 2019. And in this case, we had some items indeed sitting in the results in the third quarter of 2018, which related to some benefits of our asset network optimization. That's last year. And this year, we had some extra costs related to the TSLAs which I called out. And you will always have, during the quarter, some of these items, and it is just good practice to split it up and to clearly show how we are managing the business and where we are heading to.

[Chetan Udeshi, Research Analyst]

No, that's -- the bridge is very useful. Maybe just if I can sneak in one more. In the report, there is this mention about service agreements with the specialty cans and some royalty that you guys are getting. Is that sustainable in terms of maybe the contribution you have on the sales line and probably some contribution from that on earnings line as well?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes, that's a good question. So the service agreements with Specialty Chemicals, they will end -- it's mainly related by -- to IT, by the way, and they will end by the end of this year. So that is one. And then there is indeed some royalty agreements, which is also ended -- ending by the end of this year.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

By the way, just to build on that, that comes into our business other, so outside of the business reporting. And that's why we've been indicating that for next year, that our business other costs will be much more in line with what we said as the guidance for 2020. So that's now a little bit -- I would say, looks a bit better, but we have been pretty transparent of that over the year on what the other was going to be for 2020.

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. It's just that, that looks a little bit better because of the brand royalties.

[Operator]

Our next question comes from Mr. Alex Stewart from Barclays.

[James Alexander Stewart, Chemicals Analyst]

Hello. Good morning. My questions have actually been answered. Thank you.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Okay. Thanks, Alex.

[Operator]

Our next question comes from Mr. Matthew Yates from Bank of America.

[Matthew John Peter Yates]

A couple of quick ones. The impairment you took, can you say -- does that relate to the BASF assets you acquired a couple of years ago? Or is that something else? And then the second question, could you just elaborate a bit more on the working capital performance? We obviously had a lot of cash out in the first half. Seasonally, I think it's normal that you do recover some in Q3. But given the size of that outflow in the first half, I was surprised that there wasn't more of a working capital benefit in the quarter. Can you just elaborate a little bit on what's driving that? And how we should be thinking about Q4 for the full year number?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. Thanks, Matthew, for the question. On the impairments, and then Maarten can talk on the working capital. On the impairments, we have to bring you back in time when we did the 140 cells in detail, what's in there, what's the performance. I think we did a lot of work on that. And that basically then leads us to at one point to say, look, some of the businesses we tried, we did all sorts of stuff, the pricing and then you get to those conclusions.And yes, there are some parts of that which were related to the BASF Industrial Coatings acquisition end of 2016. Again, that was a relatively heterogeneous collection of businesses that came in. Some of them, very good; and some of them, basically, after evaluation, felt this is not what we had expected, as you typically have in an acquisition like that, that has a number of very different businesses in there. So that was part of the element. And then typically with impairments, I mean you have to go through those tests and you come to relatively smaller amounts that basically leads to an impairment. So I don't think there's anything more exciting than that in that list.On the other one, working capital, Maarten?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. So on working capital, a few points here to mention. Yes, it is indeed, as we indicated, higher versus last year. It's maybe still good to remind everybody that if we look at our working capital relative to our peers, we're actually doing pretty well, but it doesn't mean that this remains a focus area for us on the inventory side of the house. It includes some stock buildup, which we have been building up in anticipation of a possible Brexit. So that is included. On the receivables side, we see some extra receivables on the back of the acquisitions, the bolt-on acquisitions we did, but it's also kind of -- and regional mix plays through that. And the payables, that is also an area where we feel we can still further improve. So overall, for the fourth quarter, I would expect that we see kind of a bigger delta coming down, bringing it maybe closer to last year's level.

[Matthew John Peter Yates]

And just a follow-up for the sake of argument. I think earlier on the call, you talked about flattish volumes in 2020. Obviously, that could change with the market. But under that assumption, how would you think working capital moves in 2020?

[Maarten Jan de Vries, CFO & Member of Management Board]

I would say from a working capital kind of development, I would take it similar to what we've seen this year. There is no reason why that would be, from a seasonality, would be different.

[Operator]

Our next question comes from Ms. Lucy Hancock from Bernstein.

[Lucy Hancock;Bernstein;Analyst]

My question is building slightly on the previous question regarding cost savings. As we've already sort of highlighted, the EUR 19 million of cost savings in the quarter is quite a bit less than the H1. I guess we just want to understand that do we then expect -- or do you now expect it to be incremental for the following quarters of next year per quarter? Or do you see the total EUR 310 million as maybe a conservative target? And then following on from that, if it is a conservative target, what do you think will drive acceleration in cost savings?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. So on the cost savings I indicated, so the EUR 310 million is indeed the EUR 110 million we did last year and the EUR 200 million program we announced at the end of last year for 2019, 2020. That EUR 200 million cost-saving program is fully underpinned and being executed. And then it is just a matter of, from a timing perspective, how do we see that coming in quarter-by-quarter. We have indicated earlier that it is approximately EUR 100 million this year and approximately EUR 100 million next year. But it is, of course, all related to the execution and the timing when it falls in the quarter. And I mentioned, I made my comment earlier on the kind of the phasing and the developments in the third quarter.

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Lucy, in the deck, in Chart 10, I think we give quite some detail around what the savings have been per quarter, including even what the carryover has been. So that probably should give a good picture on where we are and why we are on track.

[Operator]

Our next question comes from Geoff Haire from UBS.

[Geoffrey Robert Haire, Managing Director and Equity Research Analyst]

Can I just come back to pricing again? Given that you've now got positive raw materials coming through in Q3 and sort of going forward, how long do you expect to be able to hold on to the price increases that you've pushed through already? And I appreciate that you're moving towards more margin-focused to try and offset any pressure from that. But just wondering how long you can hold the raw -- the price increases you pushed through.And then secondly, Thierry, you made some comments on Performance Coatings into 2020, but weakness continuing. Is that mainly because of the auto market? Or is there other reasons, other end markets that you see as struggling as we move into 2020 as well?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. Okay. So let me maybe -- okay, let me address the first question on pricing. I think we're pretty bullish on how we're going to be able to maintain our margin there. So the -- and you actually expand on it, differences between Deco and Performance Coatings and then differences in different markets there. For deco, it is a lot of distribution market. And in fact, one of the nice things we've seen in this whole exercise is that we obviously have a strong brand and distribution setup that enables us to drive pricing and to get margin in there. So I think our Decorative Paint businesses are very much outside of the mindset of a cost-plus, but really go around what is market pricing. So I'm pretty confident in general for deco, and that has been proven in all of the 4 regions, by the way. On Performance Coatings, also there you have to make differences between businesses where you have a couple of suppliers to a handful of big customers. I mean that becomes much more of a how do you manage it. So that's where we really go to active margin management. And to be honest, that maybe in certain cases, top line pricing may shift, but it enables you with the mix of products you supply to those customers to still maintain or grow the value that you extract from those markets. So there, I'm relatively confident that we will be able to maintain and actually expand on the current margins that we have. My comment around the pricing was that we probably go less to the sticker price and to what is the value that's derived from those and keep expanding the value. Given the unprecedented increase of raw materials, I think the approach we've taken was pretty successful to go full pricing because that was the fastest way to recoup what was raw material impact in our businesses. The second thing, on Performance Coatings, maybe just to put the record straight. I mean all in all, we do not have our business model based on an improvement of the Performance Coatings businesses. Do we hope that? Yes. But I think that would be not responsible to build our internal costing and our business model on it. Now you have businesses that are doing extremely well for us in Performance Coatings. Powder Coatings is showing growth despite quite a drag from the automotive part. In there, they actually show nominal growth, which shows the underlying businesses are very strong. If you look at our aerospace business, continues to be very, very strong. Our packaging coatings business is extremely strong with a shift from plastic bottles to aluminum cans for beverages and food packaging. So there, we have a strong technology, gaining share in a growing market. So that's a nice place to be.So you have the very strong parts there. Yes, anything related to automotive isn't very good. So that's why we have built our own model on a relatively subdued view on volumes for next year. That may actually be what pans out, and then we're prepared for that. If there's an uptick, we'll take it any time.

[Operator]

Our next question comes from Ms. Georgina Iwamoto from Goldman Sachs.

[Georgina Iwamoto, Associate]

Just 2 left. The first is you talked about the flat volume outlook for 2020. I was just wondering if you could give us an idea of what you think your customer inventory levels are at this point and if that would be a kind of area of upside to your demand expectations?And then the second question is, I'm going to try again but from a different angle, for raw material guidance. You said that you've got good visibility of costs for the next 6 to 9 months out. I was wondering if you could maybe help us understand the progression of both kind of gross margin versus EBIT margin. Do you think that your costs are going to really be coming through SG&A? Or how do you see COGS developing?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. Okay, Georgina, I'll take the first one on the flat volume outlook and then inventory. Inventories are probably a bit lower than they usually would be, but it's such a spot -- I should say, so different if you go from business to business and region to region, that I'm not sure we can draw any conclusions out of that. And in fact, as you can imagine, in markets like automotive, we are not directly supplying in the -- to the OEMs, so we're basically supplying Tier 1, Tier 2. And there, you can have a lot of speculation on inventories in the channel if that signal -- the sale signal, for example, for cars were to readjust. Typically, you are more negatively impacted the further you sit down in that channel, and you get a bit more of an upside if you go there. But we're still looking. If you ask 3 experts on what the car industry is going to do the next year, you get 3 different answers. So we'll see it when it comes. But I think inventories are probably a little bit lower, but I -- that might be a positive, but I would actually downplay that to some extent because it's across the map, I would say. On the raw materials, I did say with my big mouth that we have a 6-month view, which you would expect us to have, by the way, but I would go back to margin management. So we have to go a little bit away from pricing and then -- I would say almost a disconnected pricing activity from what your ROS do. So I think that we are thinking now in margin that's being delivered. And as we earlier said, there are certain elements where we feel pretty comfortable that we can continue to expand our margin. There are some other markets where I think there's going to be some pressure to align. And there, we're going to go more to margin management than the exact pricing.I don't know, Maarten, if you want to add to that?

[Maarten Jan de Vries, CFO & Member of Management Board]

No. Exactly that is -- I mean since the middle of this year, the focus is really, with all the pricing actions behind us, the focus is really on margin management. And we've also said with all the pricing actions having been executed, we start to see that spread coming through from our margin perspective, and that's what you see exactly now in the third quarter and that's also what you will see going forward in the fourth quarter. So -- but it's all, from here onwards, it's all margin management.

[Georgina Iwamoto, Associate]

And just a follow-up kind of on the margin side. Your third quarter gross profit margins were actually slightly lower year-on-year, and I think that's because you have some identified items there that are not in your EBIT margin. Can you confirm that gross margins were, on an underlying basis, actually up year-on-year and maybe quantify that for us?

[Maarten Jan de Vries, CFO & Member of Management Board]

Yes. In fact, so you are spot on. Indeed, that is purely due to the fact that if you look at those numbers, identified items are buried into those numbers. So that's not the right proxy. So indeed, the underlying gross margin was up. And just to be precise, the underlying gross margin was up almost 2% in the quarter.

[Operator]

Our next question comes from Mr. Mubasher Chaudhry from Citi.

[Mubasher Ahmed Chaudhry, Vice President]

Just the one, please. With the announcement of the buyback, now the balance sheet, I think, still remains quite well below the target leverage, so how do you rank these priorities for capital allocation going forward between increasing the dividend, bolt-ons or a further buyback?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes. So again, to avoid confusion, the EUR 500 million that we have announced is to be completed during the first half of 2020. So we'll really look at how the business is performing, et cetera, to see should that be an add-on, should it be something different, et cetera. So I just want to make sure that we do it more in a modular version to keep flexibility, but at the same time stay on our promise of getting to the leverage that we need to have. So you are right, if you look at our business models, there is obviously -- there's other things that we will come out with then to get to that leverage. So that's one element. Two, I think the question on so how do we -- how to prioritize it, it's actually pretty simple. I think it's what creates the most value. So share buyback, of course, has the biggest impact if you feel that your shares are undervalued. And -- well, okay, so we announced another share buyback, so you can draw your own conclusion out of that. And then if there is a bolt-on acquisition that comes in, then you look at, okay, so you compare it now to what is the most value-adding and what is the highest accretion you can have on your medium- and longer-term return to shareholders. So it's a relatively straightforward comparison. And I think we've been very clear that we will capture that leverage and we will take our actions based on what is the most accretive in our analysis at that moment of time to shareholders.

[Operator]

Our next question comes from Laurent Favre from Exane.

[Laurent Guy Favre, Research Analyst]

I've got one follow-up, please. Related to the health warning, the Tier 2-related label that has been apparently now mandated by the EU. And I'm just wondering, do you think that will just lead on players to add a label on paint and coatings? Or do you think that the industry could move to -- into particular strategies and differentiated strategies around Tier 2 content for both paint and coating?

[Thierry F. J. Vanlancker, Chairman of the Board of Management & CEO]

Yes, good question, Laurent. It's a bit of a very specific European situation where I think the whole industry is a bit confused on why this is being done. I think the labeling is specifically for professional markets in powder coating, which I think that market is pretty well aware of what it is and what it isn't. As you may know, in our professional coatings business, there is already a whole myriad of messages on labels that are on there. So far, I mean it's actually not -- it's not intended -- also that legislation is not intended for, I would say, more the consumer market.And as you might imagine, there has been from all of the suppliers, by the way, to their customers, there has been a lot of communication on what it is and what it isn't and what it's based on, et cetera. So I think that professional market is pretty, I would say, pretty relaxed and already had the, as you would expect, had all of the precautions in place on how they handle these materials. So I would think this is going to be a kind of a nonimpact situation.Does that answer your question?

[Laurent Guy Favre, Research Analyst]

Yes, absolutely.

[Operator]

No more questions at the moment.

[Lloyd Midwinter, Director of Communications & Investor Relation]

Great. Well, thank you very much to everyone for joining the call today, for your continued interest in AkzoNobel. And if you have follow-up questions, please feel free to contact Investor Relations. All contact detail is available on akzonobel.com.

[Operator]

Thank you. And that concludes today's conference. Thank you for your participation. You may now disconnect.