Kone Oyj

OMXH:KNEBV

Earnings Call Transcript 2022-Q1

[Natalia Valtasaari, executive]

Good afternoon, and welcome to KONE's first quarter earnings call. My name is Natalia Valtasaari. I'm Head of Investor Relations at KONE, and I'm joined here today by our President and CEO, Henrik Ehrnrooth; and our CFO, Ilkka Hara.

As usual, Henrik will start by going through the highlights of the quarter, both in terms of financials, business performance and market development. Ilkka will then follow up with a bit of a deep dive into the financials and Henrik will end the presentation with the business and market outlook before we move into your questions. [Operator Instructions]

That's with it, I will hand over to Henrik.

[Henrik Ehrnrooth, executive]

Thank you. Welcome to this call. And to start with, it's clear that it's been a very eventful quarter. A lot of good things, a lot of good developments. Also, we know that there are a number of challenges in the market. So if we start with the highlights for Q1. Really -- the key highlights were that we had very good growth in our orders received, and I would say an excellent start to our services business for the year there. So really a great continuation to what we did last year in services.

At the same time, it is clear that I wish I could present this in a more positive environment. We have some significant concerns around us. Of course, the war in Ukraine is creating a lot of concerns. And of course, there, what we are doing a lot is to make sure that all of our people everywhere are safe. And for example, in Ukraine, we do check in with our employees there every day, and we're able to do so again yesterday.

Of course, also the COVID-19 restrictions in China are causing a lot of challenges overall. So we know that supply chain disruptions have intensified as a result of this. However, what is also positive, though, is that we have progressed very well in our actions to offset the impact from costs in the supply chain. And we'll talk about that more.

But it's clear that, that remains a top priority for us. But clearly, momentum there is very positive.

If I start to highlight numbers for first quarter. As I mentioned already, it was really about growth in orders received. However, our operating income was clearly burdened, which is a concern of ours. The orders received at EUR 2.4 billion grew at 10.6% in comparable currencies, really broad-based and good growth. As a result of that, our order book hit again an all-time high at EUR 9.3 billion and growth 7.3% compared to last year. Sales was more or less flat in comparable currencies at EUR 2.4 billion, and our operating income was down from EUR 250 million to EUR 171 million. So that's clearly a concern of ours.

And the adjusted EBIT from EUR 250 million to EUR 196.5 million, and EBIT margin from -- adjusted EBIT margin of EUR 10.7 million to EUR 8 million. So it's clear that top priority for us is to restore our margins. Our cash flow was an okay level of EUR 218 million compared to EUR 425 million last year, EUR 425 million was clearly an exceptionally good number and EPS of EUR 0.25 compared to EUR 0.37.

So as I mentioned at the beginning, it's been an eventful quarter, and we all know that a lot of things have changed and a lot of developments. What I'm very pleased about is, again, the resilience of our people at one of our whole organization about the motivation. When I look at people being locked down in China, how they continue to do great work with good motivation and all around the world, how KONE's employees are performing in this environment is just excellent to that time, very, very happy about it. So big thanks to all of them.

Now let's start with a few highlights of our business, and let's start with some innovations that we launched in March this year. So March this year, we had a first, we'll call KONE Experience event, a very big event for our customers and partners. And then we launched 3 types of solutions that I think reflect extremely well the needs of our customers just in this current environment. We strengthened our offering for smart and sustainable buildings. We're really showing the way here. key part of our strategy. We launched solutions that help our customers compress their schedules, improve their productivity on construction sites and also broadened our offering of our connected solutions to enable better adaptability by the launch of DX Class elevators now also in United States and Canada.

But if a little bit closer to this, what have we done on solutions to accelerate construction productivity for our customers. So it's all about our construction time use solutions that we brought digital services to, to improve insight and uptime for those units that are in very heavy use during construction. Now the point here is really that now we brought, again, a broader offering, so we can bring elevated services into buildings at a much earlier stage that really significantly improves the productivity for our customers when they can start bringing workers much more efficiently in the buildings.

An example of this is that we launched a standardized version of KONE JumpLift for machine-roomless elevators and is really available for all building heights. So already a long time ago, we brought a clear revolution to the industry by bringing JumpLift that goes up as the building goes up. Now we can bring that also to lower-rise buildings and really customers who have used this so far have seen really clear, clear improvements in their productivity. So I think very well suited to a highly inflationary environment where productivity is at top of everyone's agenda. Today, we have also launched our 14th sustainability reports, a 14th year in a row. We've done that. And some of the highlights from it, you can find it in actual on our website.

As you know, we are committed to science-based targets to a 1.5-degree pathway. We have the most ambitious targets in this respect in our industry, both for our emissions from Scope 1 and Scope 2, but also life cycle Scope 3. Now for so-called Scope 1 and Scope 2. So emissions from our own operations, here target is a 50% reduction by 2030. We now reduced in absolute terms from the baseline in 2018 by 15%. A Today, already 80% of the electricity that we use is renewable, target is 100%. So we clearly -- there we are ahead of schedule.

Now then we also have a target to reduce the emissions relative to products ordered Scope 3, so the life cycle emissions for our products and solutions. Now here you can see plus 0.4%, hey, going in the wrong direction. Well, what's going on here is that actually the energy efficiency of our products has clearly improved again since 2018, the baseline. However, when we are selling more into countries, that use more fossil fuels. Therefore, that is increasing the life cycle emissions. So fundamental improvement, but clearly, here, we are speeding up our actions as well.

We also have a clear target for diversity, equity and inclusion. One of those targets is to have 35% of our director-level positions held by women. Last year, we increased that from 19 to 21. So we've made some progress there. So we're on the path of getting to our 35% target. And in safety, we continued our good performance with the industrial injury frequency rate globally of 1.6 which was an improvement compared to pre-pandemic levels. So it's clear that we are in the past, we have a lot to be done. And at the same time, we are progressing.

Also an important event during the quarter we announced that Karla Lindahl has been appointed Executive Vice President responsible for South Europe and the Mediterranean region and a member of the Executive Board on April 1. So Karla has an 18-year career at KONE, she's held many leadership positions within the company. Latest as a Managing Director for Finland and the Baltics. So very happy to welcome Karla into my direct team.

So those are some highlights. First, innovation, sustainability and some appointments also in the quarter. As I think many of you remember in connection with the first quarter result, we dive a little bit deeper into the prior year development of markets and market share. So -- now we have that data ready. And what I'm happy to say is that we had good development last year as well. So just to give the context first, Global new markets were a bit over 1 million units last year and the markets grew at about 7%. At KONE, we sold last year 196,000 elevators and escalators and we grew overall 9%, so slightly faster than the market.

The maintenance market was close to 20 million units, growing at 5%, and we grew 5% in units and 7.5% in value. In value, we, again, are the big players with clearly the fastest growing again last year.

Now best performance in new equipment we had in the Americas and in Asia Pacific outside of China. And in maintenance, we progressed in most places. I think one highlight there in maintenance was that in the large Indian market, we became the market leader last year with a very fast growth and great trajectory. So that was one of those nice milestones to take a #1 position. And in many parts of Europe, we are also improving our position.

So overall, slight improvement in many places. Now what about the markets in Q1. As I mentioned at the beginning, the positive thing is that we have a very positive market backdrop. New equipment markets are growing, but it is strong growth in North America. Europe also growing, then more stable in Middle East. Asia Pacific outside of China recovering strongly. Although the China market records or liquidity constraints was down 5% to 10%. So therefore, we had a somewhat decline in Asia Pacific. But a lot of good growth opportunities still around the world as we could see that we were able to capitalize on.

The services markets also developed nicely. Maintenance markets, I would say, very much trend to growth -- slight growth in the mature markets and good growth in Asia Pacific. Perhaps the highlight was a very positive market backdrop in modernization. Very strong growth in Europe, Middle East and Africa, Asia Pacific and also good growth in North America. And as you saw, we were very well able to capitalize on this. So modernization is really a highlight of great growth in the markets right now.

Then a little bit more on China. We all know that the Chinese market has been more uncertain. If we think about the market overall, we can see that liquidity restrictions continue to have an impact on the market. So the markets declined, as I said, about 5% to 10% and very tough pricing environment. Now we started to see the first easing measures introduced in Q1 to support housing demand.

So when we have restrictions, we know both on demand and on the supply side, it's really on the demand side, we start to see the local authorities are starting to ease restrictions. And now in the past weeks, those have accelerated. So let's see how that will impact the market. Of course, as everyone knows, the really big thing now are the COVID-19 restrictions which have increased uncertainty and have had a big impact throughout the market.

So today, more than 50 of the 100 largest cities in some form of lockdowns, 90 or 100 large cities have some form of restrictions. So really a big impact. And really where this has impacted the most is on logistics and ability for anyone ready to operate businesses and to deliver to their customers irrespective of what business you are in. So this uncertainty is expected to impact second quarter market activity and particularly, of course, deliveries because of a, I would say, very disruptive logistics environment in the country overall.

If I look at our operations, we could see a solid demand for KONE's solutions. Q1 deliveries only somewhat impacted towards the end of March because of site closures and logistics while their maintenance remained resilient. Our factories in Kunshan and Nanxun were closed for about 3 weeks in April. Now those are gradually opening up. But like for anyone getting supplies and logistics continue to be -- continues to be challenging in the market because of the restrictions that are in place quite broadly. That is about markets overall.

And with that backdrop, I hand it over to Ilkka to talk more about our financial performance.

[Ilkka Hara, executive]

Thank you, Henrik, and also a warm welcome on my behalf to this first quarter results announcement webcast. I'll start going through our financials with orders received development. Overall, we saw strong growth in our orders received in the first quarter. Orders received was EUR 2.4 billion on a reported basis growth of 16.7%. And also on a comparable basis, 10.6% growth is a very strong performance for the start of the year. Strongest growth in our orders hit was in Americas followed by Europe, Middle East, Africa and Asia Pacific, we also grew.

If I look at particularly China within the Asia Pacific market, then in China, we grew slightly in units and were stable in monetary value as both mix and pricing contributed negatively. There is a good performance against the market, which as Henrik highlighted, was down 5% to 10% in the first quarter. And if I look at our orders received development from a margin perspective, although we did continue to see a slight decline in our orders received margin year-on-year, we did continue to see an increase in margins sequentially. So from Q3 to Q4, we were able to increase slightly our margins and now that continues in Q1 as well.

Our actions on a product cost as well as on the pricing front continue to yield results. And the momentum is good. From a new equipment perspective, if I look at the total picture in terms of increased costs over the last year as well as then what we've done in terms of product cost and pricing actions. We are now roughly the 50% there encountering the headwinds we've seen in our new equipment business global.

In the modernization business, we actually are doing better and we are close to being able to mitigate these cost increases on a cost level that we now see for the orders that we booked in the first quarter. And although it's not impacting orders, I think still from a pricing perspective, where we've seen best opportunities to increase prices in this environment is in the maintenance business, and that contributes positively to the overall business as a whole. So good progress there, although we continue to see our costs increasing and the raw material headwind that we highlighted earlier, to be EUR 100 million to EUR 150 million in this year now is EUR 150 million to EUR 200 million for the '22.

Then to sales. Our sales grew on a reported basis, 5% and were EUR 2.442 billion. From a geographical perspective, strongest growth in Europe, Middle East, Africa, where we grew 7%. In Americas, our sales grew slightly at 0.4%. And in Asia Pacific, our sales declined 7.7%. And there, that development was largely driven by China, where our developer customers, they're tight liquidity impacted our deliveries. We wanted to continue to be very focused on our payment terms, and that had an impact to our deliveries. And as Henrik said, towards last week of March also a slight impact from the restrictions that we've seen in China due to COVID-19.

From a business perspective, China impacted our new equipment deliveries, and we saw a decline of 9.4% in the revenue. But as Henrik already highlighted, very good performance in our services business. modernization growing 11.5% and also our maintenance growing very strongly at 8.7%. Good performance there. Both units contributing to this. But also, as I highlighted, pricing having an impact as well as our 24/7 connected service and other value-added services.

Then to adjusted EBIT and profitability. Our adjusted EBIT for the quarter was EUR 196 million, and adjusted EBIT margin was 8%. We can't be happy with the development here. While we had positive contribution from the good development in services. At the same time, from a growth perspective, the profits were impacted by the new equipment sales decrease in China. At the same time, we continue to see profitability positively been impacted by quality, which continues to then help us to drive good productivity in our operations. At the same time, the headwind for this quarter from the increased material component and logistics cost is around EUR 80 million, then impacting our adjusted EBIT development as the biggest side.

Cash flow was for the quarter EUR 218 million. Against last year's exceptionally high cash flow, this is a more normal development. And we saw in the quarter, net working capital having a slight negative impact. But if I compare it to last year, our cash flow was down due to our operating income being down EUR 79 million as well as then from a net working capital perspective, although maintenance business growth and invoicing in the first quarter had a positive impact. We did have higher than average inventories due to the supply chain disruptions.

We see that, that's a good thing we can deliver to our customers while having a slightly higher inventories. But as highlighted also in the fourth quarter results, we did have payables that from a fourth quarter slipped over to the first quarter and had a negative impact to our net working capital then in the first quarter. But all in all, as I always said, cash flow on a quarterly basis does fluctuate, and you need to look at it in the longer term.

But with that, I'll stop the financials review and hand over back to Henrik to talk about market and business outlook for the year. Thank you.

[Henrik Ehrnrooth, executive]

Thank you, Ilkka. As you say let me wrap up with outlook. If we start about overall market outlook for 2022 equipment. We expect that the Chinese market will decline significantly. That means in practice, 10% to 15%, of course, due to the liquidity restrictions and COVID-19 restrictions. In the rest of the world, we expect the new equipment markets to be positive and improve.

Modernization markets continue to be growth markets across all regions that is positive and maintenance is expected to return to pre-pandemic growth trajectory. So slight growth in mature markets and clear growth in Asia Pacific. So that is market outlook, most places quite positive.

And then we look at our business outlook for 2022 is specified. We now expect that our sales to be in the range of growing in the range of 2% to 5% in comparable currencies compared to 2% to 7% previously. And we expect our adjusted EBIT to be in the range of EUR 1.180 billion to EUR 1.280 billion. Of course, assuming that foreign exchange rates remain about at the current level, they would give us a tailwind of about EUR 70 million. And what is important is that this outlook is dependent on the COVID-19 restrictions in China being lifted during the second quarter, and we can see a rapid recovery thereafter. And there also, of course, something that will impact the level of restrictions will impact our deliveries, particularly in China.

Now we have a number of things that are supporting our performance particularly the positive outlook and great performance we have had in services as well as our solid order book. And we expect that the effects of our product cost actions, productivity actions and pricing will start having a positive impact towards the latter part of the year. And as Ilkka mentioned, we have had good momentum in these areas now in the quarter. What's burning our results, it's clearly further headwinds from material component on logistics. So we expect that to be further EUR 150 million to EUR 200 million this year. It was about EUR 200 million last year, so another EUR 150 million to EUR 200 million this year. Clearly, COVID-19 restrictions in China are having an impact on deliveries and also the competitive dynamics and liquidity constraints in the Chinese property market. That's our outlook.

And if I wrap up, the good thing is that while there's been a lot of uncertainty in the world, we have good growth opportunities and we can see good market activity in our industry. We can also see that the actions we have taken to address our headwinds from supply chain costs and others are actually growing very well. So pricing is improving. Productivity is improving. Our product cost actions are actually quite good at the moment. And we continue to drive differentiation through adaptability, productivity and sustainability that are the core of our ambitions.

So with that, I thought, we start taking questions.

[Operator]

[Operator Instructions] We will now take our first question from Andrew Wilson of JPMorgan.

[Andrew Wilson, analyst]

If I can start with the first one. You mentioned around the meeting actions in China having in recent weeks and having started in the Q1. What sort of typical lag do you see in terms of easing actions before we actually see that working [indiscernible] improved marketing conditions. Sort -- I think I've heard previously sort of 6 to 9 months in terms of a thought process, but very interested in terms of, I guess, your experience in terms of when you would expect to see that come through in the market.

[Henrik Ehrnrooth, executive]

Thanks. So yes, easing, what we were talking about is really on the demand side. So for property buyers to be able to finance and buy apartments better it's clear that, that is a little bit further out because first you need to get demand there, but that clearly then gives more confidence to builders to start again buying land and starting new projects. So usually, the lead time is not too long, maybe a couple of quarters or so that they should have a positive impact still this year.

[Andrew Wilson, analyst]

And the second question is, I guess it's a bit of a kind of philosophical question in terms of running the business in this period. It seems to me, if I look at the obviously, the strong market share performance in 2021, the very strong orders you've reported for the Q1. It doesn't seem to me that the business is losing a great deal in terms of, I guess, that productivity towards growth and that focus on growth.

And I'm just wondering sort of how you're balancing the longer-term prospects, which seem to be going very well versus, obviously, the short-term challenges and kind of if any of the actions that you're taking at the moment you think are going to be kind of sticky actions, which help over the longer term?

And I guess linked to that is, do you think you're dealing with this downturn in a different way to some of your competitors? So I appreciate that's quite a broad question, just interested in terms of how you're thinking about that.

[Henrik Ehrnrooth, executive]

Sure. Well, clearly, the impact we're seeing from supply chain disruptions and things like that is something that we have not experienced for a very long time. And something, of course, we hadn't expected. But it's clear that when you have a tough situation like this, you take a lot of actions, you learn to do things in a new way. I think every business around the world have to learn to live in a total different environment.

We have to remember that we come from a 15-year period of, I would call it, extreme price stability in the market, if you think from inflation or material costs or so clearly fluctuated, but still longer term quite stable. And that is, of course, for every industry, every business given a certain backdrop of how you need to operate. And you've been able to make longer-term commitments and been able to do it in a stable way. I think now business is changing. I think everyone will have to have more indexation in contracts we'll need to reflect that inflation and product cost changes in a more dynamic way than in the past.

So it's clear that we all have to change a little bit the way we operate and that will definitely be for the better longer term. And what I see, usually, I would say, when you benchmark across industries, on a product cost basis fundamentally most companies are getting, let's say, 3%, 4% fundamental product cost improvement year-over-year. Now when you really put an enormous focus and you can see you can get much, much more. And how do you continue driving that.

So there are a bunch of things that improving how you operate your business. But I think this way that how you operate in a total different environment where we don't have this extreme price cost stability that the world was used to over a long period of time means that we all have to operate in a slightly different way. We're actually quite much in a different way in many places.

[Operator]

We'll take our next question from Klas Bergelind of Citi.

[Klas Bergelind, analyst]

Klas Bergelind from Citi. So the first question I have is on the revenue recognition out of the backlog. And it's a pretty big growth step that is required for the rest of the year at the midpoint of the guide. Obviously, I appreciate that the backlog is up 7% organically, but you've started the year weak with sales weak both in Asia Pac and Americas, I mean, obviously, maintenance growth is solid, but what gives you the confidence you can convert that backlog as we have this bottleneck. You say that China is depending on China. But is that really enough? I will stop there.

[Ilkka Hara, executive]

I'll maybe start. First, I would say that we have a very good backlog, as you highlighted, our order book gives us a good visibility and opportunity to deliver against that guidance. And as you've seen also in our maintenance business, we've seen very good growth now for few quarters now starting from last year and now continuing to the first quarter. So all of those contribute positively. But as I said, one of the assumptions we are having in our guidance is that we do expect and assume that the markets and the restrictions in China are lifted and we can operate more normally during the second quarter and therefore, be able to catch up during the second half of the year from a revenue perspective in China.

So those are the assumptions. And at this point of the year, we still are booking orders for especially modernization business that we will deliver during the year. So yes, we do continue to also expect new orders in second and maybe beginning of the third quarter, that will still be recognized as revenue during '22.

[Klas Bergelind, analyst]

And I guess, the conversion is quite quick in China when that opens up. And then my second one is on the margin performance. And listening to you now, Henrik, it still feels like the second quarter can be really cost configuring the China lockdown that feels more like a second half opportunity than being lifted. The liquidity constraints impacting deliveries in the second quarter and that pricing is yet to feed through from the longer backlogs outside China.

When I then consider your EBIT guidance with a still tough margin for the second quarter, just quite a big margin uplift in the second half sequentially. What gives you the confidence on pricing in India and Americas gradually kicking in. Is that really what should drive it then from a margin point of view, if the second quarter is maybe 10% plus.

[Henrik Ehrnrooth, executive]

Well, I'm not going to go into each quarter how they are sequentially going to go. We have our overall guidance, as you mentioned, Clearly, second quarter will be quite a lot influenced by the lockdowns in China. It's clear that for everyone, deliveries in April are on a low level. I think orders are probably at a better level, but that clearly has some impact on revenues and therefore, margins. And then we have to see how it recovers from thereafter.

We have given our assumption the way we see it. But as you know, that always seasonally, for us, Q1, always has a lower margin and then we have better margins in the other quarters. But as we have said also that we expect that the actions we take on pricing and productivity and product costs and so forth will start to impact us towards the latter part of the year. In the pricing improvements that we're doing now, it's clear that, that is something that impacts more -- I think the new equipment impacts more 2023, whereas in the services business, we are seeing a faster drop through of that.

[Ilkka Hara, executive]

And I would maybe add to that also that the product cost actions that we are making they will take some time to get to then production and then to deliveries, and that's impacting more the latter part of this year. And those actions, we have quite a good visibility on.

[Klas Bergelind, analyst]

Yes. No, I appreciate that. It was just the -- I know that the margin will be better in the second half, but it looks like flattish margin implied if you are reporting a weak 10-ish second quarter. But yes, I'll get the moving parts.

[Operator]

We'll take our next question from Jeff Sprague of Vertical Research.

[Jeffrey Sprague, analyst]

I was just hoping if you could clarify if you don't mind, the price cost side of the equation. And specifically, my first question is, you've noted that the price is covering about 50% of the inflation on the new equipment side, could you clarify, was that an order comment related to Q1? Or is that what you're expecting for the full year?

[Ilkka Hara, executive]

I'll take that. So my comment was related to both our actions in pricing as well as in product costs. Those are the mitigating actions. And it was related to our orders received orders that we're booking in first quarter. How much in those, we've been able to counter the cost inflation that we've now seen. And it is a new equipment about 50%, in modernization, it is clearly higher than that, it's close to being able to mitigate the cost increases we've seen. And that was my comment and it was about orders.

[Jeffrey Sprague, analyst]

Great. And then just taking that a step further then, I think the comment that the cost headwind is EUR 150 million to EUR 200 million for the year. Could you give us the context on expected price realization against that headwind as well.

[Ilkka Hara, executive]

Well, I guess, we don't have a habit of commenting pricing in a forward-looking manner. And [indiscernible] that you have to customer-by-customer, order-by-order at the end negotiate a deal. And as an outcome, you get the pricing level. So we comment what we've been able to achieve, but not in a forward-looking manner.

[Operator]

We'll take our next question from Andre Kukhnin of Credit Suisse.

[Andre Kukhnin, analyst]

Can I ask about China orders to sales conversion phasing. It's interesting to see that you haven't had a quarter, I think, with orders down in units yet and yet I think you're seeing a revenue downturn. So I just wanted to check if that has changed structurally. Or was there kind of early impact from lockdowns in Q1 already? And how would you expect that kind of orders to sales phasing to play out in China over 2022?

[Ilkka Hara, executive]

Yes. I'll start with the smaller part. And just your question on the COVID-19 restrictions impact in first quarter. So it really impacted the last week or so in the quarter. So that was not impacting the conversion for the quarter that much. But we did see that the order book rotation in the first quarter, as expected, was slower. And the main reason for that was that we've been quite focused on making sure that we have a good control of our credit risk and also payment terms and that impacts our capability to deliver.

So we expect to be able to control both. And therefore, the order book rotation was slower than we've seen in the past. But we do expect, as we talked about earlier, that the market would return and that would mean that order book rotation then is more normal or more similar to what we've seen in the past.

[Andre Kukhnin, analyst]

And I'll just come back to one on the pricing. We've heard from a peer of yours mentioning going back to existing orders and I think existing responses to first proposal on looking to adjust prices there for the latest inflation in raw materials and labor cost. Is that something that you were alluding to when you were answering the question on maybe doing things differently. Is there scope for that? And if there is any scope for that, could you give us some idea of how much of a backlog could be subject to those kind of practices?

[Henrik Ehrnrooth, executive]

I think my comment was more when we think about booking new orders that probably having fixed prices for a very long period of time on any side is probably unlikely going forward. That probably needs more indexation and reflections of what we cost are at that point in time. And that we can see that our customers, builders are doing as well. So I think that this is a general trend that we see in the market. Then clearly, you also need to take action on how do you improve margins of existing orders. Of course, you have your contractual commitments that we are a company, I think we made a commitment with a customer, we will hold to that.

In some of those cases, there are some indexations, not in a very high proportion of contracts there you have an opportunity. Then of course, you have an opportunity, if you can provide more value add, you can sell more during the period and things like that. So there are -- and you can improve your productivity. So there are a lot of things you can do on that side as well. And it's clear that, that's part of the toolbox. That's very clear.

[Andre Kukhnin, analyst]

If I may just follow up on that, is there a much kind of that practice baked into your guidance for the second half because I assume going to existing contracts and enforcing escalation causes or proactively increasing value added, as you've just described, should have a fairly immediate effect should not be subject to that 12-month lead time. So is there much of that baked into your second half guide?

[Henrik Ehrnrooth, executive]

So things you can improve a bit, but it's not going to frankly, change the big picture though.

[Operator]

We'll take our next question from Lars Brorson of Barclays.

[Lars Brorson, analyst]

Maybe first on the China market outlook, Henrik. I just want to clarify. So the rapid recovery expected in H2, that's your business outlook for deliveries, installations, it's not your market outlook orders. You're still guiding, of course, down over 10%. That will be on a par with what we saw, I guess, in the market in Q1. So not much of a second half recovery, which I think you expected in your early assumption. Just wanted to check that, that is what you see right now that there isn't any evidence of any stabilization?

And secondly, maybe on China, just to like-for-like pricing, declining slightly now in Q1. It felt like we were tracking a bit better in the fourth quarter. We started talking about price hikes in Q2 last year, takes a bit of time for that to filter through. But I feel sequentially things were improving somewhat. Could you talk a little bit about the broader market pricing trend in China in new equipment? And what is sort of driving that step down sequentially that it appears to be the case for your new equipment business.

[Henrik Ehrnrooth, executive]

Okay. Should I start with the market outlook. So...

[Ilkka Hara, executive]

I'll get later, the pricing then. Yes.

[Henrik Ehrnrooth, executive]

So that's right that in our outlook, we expect the markets to be somewhat softer now second half really driven by continued challenging property markets and the impacts of the restrictions that we are seeing now, then we have to see how these easing measures and if there are further easing measures, how they impact, but that is our current outlook and estimate.

[Ilkka Hara, executive]

Then from a pricing perspective, I just wanted to clarify first. Yes, in the first quarter, we did see pricing having slight negative impact into our orders received and competitiveness, the market continued to be on a high level. So it was a very tough pricing environment in the market. But at the same time, I think what is always a combination of pricing and product cost actions.

And from our perspective, even though the pricing has been more difficult, actually, where we've seen very good progress, and I would say, best progress within the different regions is on the product cost side in China. There, we've been really able to find savings more and elsewhere, and that's contributing then positively.

And pricing overall, I mean, it has been more stable, you're referring to last year, so throughout the most of last year for us. So I wouldn't read too much into it, what I would say this way.

[Lars Brorson, analyst]

Secondly, can I ask you just on the raw material guidance, the EUR 150 million to EUR 200 million, we had negative EUR 80 million in the first quarter. How do you think about cadence through 2022. Is it another EUR 80 million in Q2 and a stabilization? I appreciate it's a very volatile environment. I'm just trying to understand what you're baking in, in terms of the recent moves you've seen in some of your key input exposures, particularly steel, of course, and what you're baking in as far as that cadence is concerned, please?

[Ilkka Hara, executive]

Yes. I guess the benchmark from last year was that in the first and second quarter, we saw less of the impact of the increase in raw materials, and then it was mostly impacting Q3, Q4. So from a comparison point of view, it is more in the first half where we see the increase year-on-year and then gradually easing towards the latter part of the year. That's the way I would think about it.

[Lars Brorson, analyst]

Sorry, can I finally just ask to maintenance pricing. It's a clear contribution from pricing. I wonder whether you could help us quantify the maintenance pricing. Are we talking about like-for-like maintenance pricing of, say, 100, 150 basis points. And how much of that, if any at all, is associated with, as you said, ARPU uplift as you transition from legacy to digital. I presume that will be on top of what refer to as like-for-like improvement in maintenance pricing, please?

[Ilkka Hara, executive]

Well, we've seen in a number of markets quite good possibilities to increase prices. I would say, high single digits and even above in some cases. Overall, it contributes to our revenue, some percentage points on top of the unit growth. And then from a 24/7 Connected Service, we get a bit more than -- a bit more on top of that. So that's the level I would talk about it in an overall level. Naturally, it is something that has continued to be a good source of growth over the last few years, and we continue to see opportunities going forward.

[Operator]

We'll take our next question from Guillermo Peigneux-Lojo of UBS.

[Guillermo Lojo, analyst]

I wanted to ask a little bit about the divergence between service and equipment modernization margins as we stand. Would you basically be able to -- I know that you don't provide the margins between the different segments. But I was interested in understanding the dynamics as we stand and with potentially what you see here on the backlog as we speak.

Could you, in a way, give us a little bit of granularity around the level of margins for equipment in North America and Europe as we stand today, where do you expect the margins to trough. And maybe just a similar comment on China equipment margins, if I may.

[Ilkka Hara, executive]

Well, as you know, we're not going to disclose our margins per business line. But what I would characterize is that -- from a pricing perspective, which was original part of the question, we are seeing that modernization projects are maybe more unique they are really about that single unit, that single building. And in that environment, we've been able to find better ways to drive pricing upwards and counter the cost headwinds. And there, we also are closer to customer, and that has contributed positively.

The competitive nature of the new equipment market maybe is a bit different, and therefore, it is -- the pricing has not progressed as well as in the modernization side. Then where do we see the biggest opportunities geographically, I would say, overall, our pricing has developed in the equipment businesses in North America quite well and then followed by Europe. And as we said already last year that Asia Pacific has been a bit slower, but I think now is making also good progress.

[Guillermo Lojo, analyst]

And if I follow up maybe a little bit on the China equipment margins. May I ask, obviously, these margins peaked in the past very closely, if not basically 20%. And we've been gradually going down with some volatility up and down, but gradually going down throughout 2021. And I was wondering whether you could give us basically now some in a way guidelines as to think about now single-digit margins for 2022, 2023? Or is it to abrupt what I just said?

[Ilkka Hara, executive]

Well, we are, again, on this part, not discussing margins neither by business or geography. And on an annual basis, I think if I look at China, it continues to contribute positively to our margins. So it's slightly up 50% as I said earlier.

[Henrik Ehrnrooth, executive]

If you think about the environment right now and the pricing that, of course, China is facing a lot of headwinds from this perspective. But at the same time, we're making what the progress there improving as well. So clearly, new equipment is the toughest business from a margin perspective at the moment. And China is, of course, really, really big there. So that goes without saying. But at the same time, we are making good progress there right now.

[Operator]

We'll now take our next question from Miguel Borrega of BNP Paribas Exane.

[Miguel Nabeiro Ensinas Serra Borrega, analyst]

Just two questions for me. Just on your expectations for China, we've seen inventory levels going up, the situation with developer is not really improving. I understand your expectation for the market to return to 2019 levels. You've now downgraded your expectations to between 10% and 15%. Was this mostly because of a weaker first half? Or does that imply also the market to be down in the second half? Because I remember you're saying your expectations for a flattish market in the second part of the year. And then are you expecting the market to kind of stabilize in 2023 or to keep going down further in units and monetary value in terms of [ liquidity ] intensely.

[Henrik Ehrnrooth, executive]

I think it's too early to comment on 2023. Clearly, as you said that the situation is quite challenging for many developers, and that is reflective because of liquidity constraints and others are -- that's reflecting now in the second half or rest of this year, if we think the market is going to be down 10% to 15% for the full year, and it was down 5% to 10% now clearly, we're going to see a decline throughout this year with this outlook. Then what is 2023 going to be? That's going to depend on the policies in the market, and we are now starting to see some easing. So let's see because we know there are many strong markets around China.

If we look at the mega city hubs and all the satellite cities around, these continue to be very active and also the secondary hubs. Those are active and they are, of course, lower tier cities where the situation is more challenging. So we still expect to have a good and solid market in China. This year, of course, down as we have expected. And what our strategy is in China is to transition all the time to go more and more into services, and that's why we're growing our service business so fast there right now. So that's kind of how we think about it overall.

[Miguel Nabeiro Ensinas Serra Borrega, analyst]

And my second question on your orders. Just trying to understand the moving parts between margins down year-on-year, but sequentially up being the second consecutive quarter you are seeing margins on orders up sequentially. Even with prices down in China, and I suppose just wanted some clarification here. When you talk about prices down in China, is that year-on-year and also sequentially or sequentially is more flattish?

And then when would you expect margins in new equipment to stabilize. Do you think pricing and cost actions will be enough to stop margin pressure in [ 2023 ]?

[Ilkka Hara, executive]

First, on my -- on the pricing front. So prices were down in China, both sequentially as well as year-on-year slightly. So that was a comment on the pricing. But when I talk about margins, it's good to remember that it's not only about pricing, it's also the product cost and cost for the development for the product cost. And while pricing has been more challenging in China, as I already said, product costs have actually -- we've been able to drive savings there in the best way in our China operations. So that's then been contributing positively towards the margins also in China.

[Miguel Nabeiro Ensinas Serra Borrega, analyst]

If I could squeeze in just one last question on M&A and the situation with Toshiba' elevator. Do you know if that asset is still up for sale? Can you update us if you had conversations with them since the last quarter? Are they more open to talk? Or is this no longer happening.

[Henrik Ehrnrooth, executive]

Of course, we are -- as you know, we don't comment on any rumors or speculations around that. And I think you should look at what Toshiba has said, it's not right for us to comment on anyone's behalf for speculate what they may do. They have made their own announcements and I think that's as much as we can say.

[Operator]

We'll take our next question from Martin Flueckiger of Kepler Cheuvreux.

[Martin Flueckiger, analyst]

Martin Flueckiger from Kepler Cheuvreux. my first 1 is on I think yesterday or today's news regarding Russia stopping natural gas exports to Poland and Bulgaria. Now realize or I seem to think that Bulgaria are not significant markets of KONE. But let's just assume that these natural gas export holds or expanded across other more important markets like Germany, for instance, or France or who knows, maybe even Finland, the way the geopolitical things are going. I was just wondering, what do you make out of this with regards to the potential impact on your industry overall and particularly with respect to your own company? That's my first question, and I'll follow up with the second one.

[Henrik Ehrnrooth, executive]

I think it's pretty clear. I'm not going to speculate what's going to happen as a company directly, we are not so dependent on natural gas as many other industries will be, but it's clearly if something like this happens, it's going to have impact on all through what it seems going to be an economy and ability to use energy and energy savings required. So I don't think it's worthwhile to speculate, but I think as an industry, we are not one of the -- ones going to be impacted the most, probably at the lower end, yes.

[Ilkka Hara, executive]

Our energy consumption is quite low. So we're talking about maybe EUR 10 million or so in a year, and the gas is goes to nonexisting to my knowledge.

[Martin Flueckiger, analyst]

Okay. And the second one is on your targeted productivity and efficiency gains. Just wondering, trying to do an EBIT bridge here. I was just wondering how much is -- do you think that's going to contribute to EBIT as a tailwind for this year?

[Ilkka Hara, executive]

Well, I think there's 2 things we talked a lot today about the product cost. And to me, that's really about manufacturing efficiency and productivity in the manufacturing. And there, we progressed well in this year.

Then on the productivity of our field there, we continue to make good progress. And in this environment where costs are inflating when it comes to labor costs, subcontracting to install elevators to maintain them. Really, the clear goal is to be able to take also productivity up to counter most of that inflation. So far, we've actually done quite a good job there.

[Martin Flueckiger, analyst]

Okay. So no specific quantitative guidance, I was looking for actually...

[Ilkka Hara, executive]

No, not a specific number that I would highlight here.

[Operator]

We'll take our next question from Joel Spungin of Berenberg.

[Joel Spungin, analyst]

I think I've just got one outstanding, which is maybe Ilkka, if I can just come back to -- I think you made the comment a couple of times about being -- about the order book rotation in China and being disciplined about credit and getting paid there. Could you maybe just elaborate sort of what that means practice. Are you actually now insisting that you're paid upfront before you will deliver to customers in China. And I'm just kind of wondering what the implications are in terms of your sort of your debt outstanding in the Chinese market. And-- is there any risk that orders are canceled.

[Ilkka Hara, executive]

Well, we continue to manage our credit risk customer-by-customer, project-by-project basis very diligently. And I would say that our team actually in China has been doing a very good job there. And in an environment where there's an increasing liquidity concerns with the developers, that's naturally very, very important. And yes, with some customers where we see the risk being on a very high level, then it means that we're dealing on a cash basis with them. But it doesn't mean that we would be dealing with all customers on that front. So it is really about judgment and understanding the risk that we are taking. And in the first quarter, clearly, we could have delivered more if we would have been relaxing the rules for that.

[Joel Spungin, analyst]

And maybe just a quick follow-up. If we look at the development versus Q4 in China. Have you -- has the credit risk situation where your customers deteriorated? Or you had to make any adjustments to any outstanding provision anything like that?

[Ilkka Hara, executive]

Well, from a bad debt provision perspective, we've increased somewhat but more normally, I think where the biggest impact is that from -- in the first quarter, the liquidity was very tight. So we had to make -- we have to scrutinize more and more of our deliveries, and that had more of an impact to our volumes than anything else.

[Operator]

We'll take our next question from Christian Hinderaker of Liberum.

[Christian Hinderaker, analyst]

More on inventories. Firstly, just be interested if you could provide an indication even if it's just a broad ranking as to how much of the inventory build was the result of, say, strategic choice to increase your buffer stocks versus cyclical factors, be the component shortages or some of the bottlenecks related to curved lockdowns.

And then secondly, interested in the intention to inventory management as we move through the year, appreciating, obviously, that inflationary effects may mean that the value goes up but interested in volumes in particular, if I can put it like that.

[Ilkka Hara, executive]

Well, overall, our inventories are quite low. And yes, we did make some choices to increase inventories for certain components that are difficult to get access to, but I would say that still most of this is really related to the complexity of operating. In a number of markets, we see our customers been impacted by shortage of also material for them to build their construction sites. And therefore, it is more complex to see which projects are going forward and the inventory is really tied up to these deliveries where we have distribution centers having a bit more content than normally, but we are relatively still talking about tens of millions rather than bigger numbers. So in the big scheme of things, it's still -- we have a relatively low inventory level.

[Christian Hinderaker, analyst]

And sorry, the forward planning for the year ahead?

[Ilkka Hara, executive]

Forward planning a year ahead. So I think I guess just in time, it's more just in case, but I don't see right now that it would have a more dramatic effect or impact to our inventory levels. But clearly, we need to think about it differently. And so far, I have to say that the combination of our manufacturing as well as our sourcing has done a very good job been able to deliver in this environment to our customers when they need the products and solutions. So I think it's a bit more just in case, but I wouldn't say that it's a dramatic change. I don't know, Henrik, if you have anything to add to that.

[Henrik Ehrnrooth, executive]

I think that's, that's good.

[Operator]

We'll take our next question from Alexander Virgo of Bank of America.

[Alexander Virgo, analyst]

Henrik, Ilkka, a quick couple of clarifications, please. I'm still not quite sure I understand why revenues were down in Q1 in China and orders were flat. I was expecting it to be somewhat the other way around. So if I understood you correctly, the revenues were down partly because of your own actions around concerns around customer health. And I guess where I'm going with this is I'm not sure that gets an awful lot better in the very near term next couple of quarters. So I'm wondering why that improves? That's the first question.

And then the second question, if I could just follow up on impact of lockdown. Could you help us understand, I guess, it's probably non-China, Asia, but how much of your China production supplies non-China or Asia or rest of world of KONE, just so we understand the broader implications of the logistics difficulties that are going to be exacerbated by the lockdowns we're living through at the moment.

[Henrik Ehrnrooth, executive]

I would be -- I think Ilkka can probably give a more accurate answer to this. But you also have to remember that first half of last year, particularly the first quarter, there was actually a very rapid rotation of the order book in China. It actually increased a lot in the first half last year. Then what developers did is that they speeded up projects to be able to sell them to improve their liquidity, then it starts to slow down. So we also have a compare that was actually a very rapid rotation. I wouldn't make a big point out of this that we have. As Ilkka said, that on payment terms, what we've done is that we've ensured that we kept our payment terms, and we haven't eased them as -- and we know the credit situation can be challenging.

We can see that actually things are at the moment, progressing there. So I would put this in perspective that the challenge, I think, for the second quarter and going forward is now the restrictions and lockdowns because -- because of the lockdowns. Logistics is really very challenging in China at the moment because the restrictions where drivers can go to. The Shanghai port is, as we all know, clogged up. So those are really the bigger challenges right now, but my understanding is that the message from customers is that they want as soon as they can proceed, they proceed.

Now if we look at the rest of Asia, yes, we supply a lot from China. Of course, we have a factory in India as well. But also there, you have to put it in perspective. I would claim that almost every building that goes up in Southeast Asia, Australia or these countries are built very much with Chinese components, be it maybe not the basic building materials, but the side elements or plumbing and HVAC and everything.

So all of these constructions will be delayed. And at this stage, we come in, I don't think we are the bottleneck. And at the moment, we've been able to find alternative logistics base to actually continue to deliver. So how it impacts our rest of Asia business will depend on how long the lockdowns are continuing. But as I said, I think you're going to see a big impact to the whole construction trade just because of all the materials, how they are supplied to the building sites.

[Ilkka Hara, executive]

Great. And still to add to Henrik's answer that relatively speaking, we are still quite local in terms of manufacturing. If you look at the global footprint, North America, Europe, India, China. So it is still an industry where distance does matter.

[Natalia Valtasaari, executive]

Thanks, everyone, for listening in. Henrik, did you have anything that you wanted to say now.

[Henrik Ehrnrooth, executive]

I could just say a couple of further comments. So thank you, first of all, everyone, for your activity, as I started this event today, so it's been eventful quarter once again, and easily, we can think about all the disruptions that we're seeing. At the same time, there are many actually good things going on there. With market growth, we've been able to capture that growth very nicely. I would really highlight our service business. I don't think we can see anyone performing growing it as fast.

So really the strategy we have had on our service business with how we're building it up, how we're growing it and the digital aspect of it. is really coming through very nicely. So that is something where we're definitely pushing the accelerator as much as we can. The Chinese property market is challenging. At the same time, orders keep coming in -- so there is still a belief there, and it's definitely believe there. But we have to see how long these lockdowns go on. How that's going to impact deliveries. That's clearly a question that we don't have all answers for. But at the same time, I can see the motivation of our team is that once we think going, they are very eager again to get going full speed.

And if you remember how quickly we at KONE came out of the COVID lockdown in 2020, I think we have some good abilities there. And of course, huge focus for us is to improve pricing, improved productivity and product costs. And momentum is good. Yes, we are not where we need to be. We need to make further progress, but I think the momentum is really good at the moment. So there also we are pushing as much as we can going forward.

So with that, happy to Natalia any final comments from you.

[Natalia Valtasaari, executive]

Yes. Just one reminder to everyone. So we just actually sent out our CMD invitations yesterday. So it would be great to have you always attending. You can find more information on the events on the IR pages and the registration information as well. Hope to see you in Helsinki in June. Otherwise, thank you for the questions. Thank you for dialing in. If there are any follow-ups, please feel free to reach out to me. And with that, have a great rest of the day.

[Ilkka Hara, executive]

Thank you.

[Henrik Ehrnrooth, executive]

Thank you, everyone.