Alfa Laval AB

STO:ALFA

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome, and thank you for joining the Alfa Laval Q3 Earnings Call [Operator Instructions]

It's my pleasure, and I would now like to turn the conference over to Tom Erixon, CEO. Please go ahead, sir.

[Tom Erixon, executive]

Good morning, and welcome to our third quarter earnings call. Let me, as always, do a couple of introductory comments.

Demand remained strong in all 3 divisions, in line with expectations and order intake reached a new all-time high in the quarter. The slowdown in the global economy is not yet visible in Alfa Laval's end markets.

The margin was negatively affected by demand capacity imbalances, especially in the Marine Division and partly related to a weak cargo pumping market, while most business units in the group remain capacity constrained, fully utilized and operate at a non-profitability level.

Note that group margin was approximately 15.5%, excluding the integration effect of the Desmet acquisition. The complexity in the global supply chains are gradually improving with invoicing as well, and this is a continuation from last quarter, and we expect that to continue also into the fourth quarter.

Finally, we are addressing the cost level in specific parts of the Marine and Energy Division, including the wind down of activities in Russia. In all, around 500 employees will be affected, and we expect the restructuring charge of somewhere north of SEK 200 million to be taken in the fourth quarter. We will be back to further information at that point in time later.

Let me then go to key figures. And first, let me just say that, obviously, as you all know, all the numbers are somewhat affected by currency and for that matter, inflation, so in comparability that creates some problem.

But nevertheless, that goes true for the total numbers that we are presenting today. Let me still say that the 13% organic growth is a very healthy level and the SEK 15.2 billion, a new record, as I indicated. The growth is broad-based across regions and applications.

The invoicing is improving, but still lagging behind order intake. The invoicing backlog is having a negative effect on the margin, obviously. Invoicing is expected also to continue to improve into Q4.

The margin declined sequentially just below 2 percentage points had 3 main components. First, the integration effect of Desmet. I indicated that earlier. You should expect that, that effect will be smaller in the fourth quarter.

Second, the low volumes in cargo pumping affected both margin and mix in the Marine Division. This may take a few quarters to restore, depending on how the order intake and inflow outlooks in the coming quarters.

And third, we do have some remaining issues related to imbalances in capacity and the old backlog execution. This will gradually improve from here. And obviously, the restructuring program is to a degree addressing this issue.

Let me then go to the Food & Water Division. Order intake was strong again, supported by the completed integration of Desmet. There was a positive momentum in most end markets, perhaps specifically with China in the Food & Water Division as an exception to the rule with a weaker demand than previous quarters.

Margins remained stable at 16.8%, excluding the Desmet effect, the dilution, as I indicated, is expected to be smaller in the fourth quarter for the Food & Water Division as well.

Invoicing grew considerably, but still, we had a positive book-to-bill in the third quarter and obviously a significant order backlog as a result.

The Energy Division continued to have a strong demand related to energy efficiency solutions, and we continue to work with capacity increases across several areas in the division. The focus on applications supporting the energy transition is continuing with a growing project pipeline. In the quarter, as you may have seen, we booked the first major project in hydrogen in Saudi Arabia being just an example of how the order backlog on energy transition is growing.

The margin was strong, reflecting a sound balance in the order book between cost increases and pricing, in addition to a positive mix effect in the third quarter.

One unit in Energy Division, the business unit Welded, struggles with effects partly from the energy transition towards renewables and partly as a wind down of activities in Russia. The unit forms part of the restructuring plan and will also be affected by the decrease of employment within the group.

Then to the Marine Division. The demand was strong in almost all areas. In fact, even with an improved demand for cargo pumping towards the very end of the quarter. Order intake is on an unusual high level in relation to the yard ship contracting level of around 1,500 ship. This is a result of a broader product portfolio, supporting the increasing environmental demands and regulations.

The margin was weak in the quarter, as I already indicated, let me just repeat to you a couple of the aspects that is affecting the margin in this quarter.

We had a continuation of the phase out of the old order book with oil prices according to plan. As we have indicated, we expect this to be more or less completed towards the end of the year, moving into Q1.

The mix change from scrubbers to ballast water continued. Obviously, we are expecting that to continue. But on top of that, with a somewhat weaker than normal margin in ballast water, that effect was a little bit bigger than normal in the quarter.

Finally, we had a low contracting of product tankers and chemical tankers for a period of time, and that has resulted in a low load and a low capacity utilization and a low mix in the third quarter. As I indicated, this may remain a challenge in the next few quarters depending a little bit on orders and in-for-out orders in the coming quarters.

The restructuring plan is addressing specific demand capacity challenges in the division with a positive impact latest in the first quarter 2023.

Moving on to Service. Service continues to grow with double digits in all 3 divisions. As noted already last quarter, this is an effect partly from high demand and partly from significant efforts in our service offering and service organization over the last 5 years. Invoicing grew, but was still held back somewhat due to availability constraints, both on the fields and in the distribution centers.

In terms of the regional performance, as in previous quarters, we see a broad-based strong demand pretty much across all of the regions. What perhaps is noteworthy in this quarter is despite that Russia is out of the mix, eastern Europe remain almost flat, and like-for-like continues to grow as to the other regions in this quarter.

Finally, on the overall order intake situation, you've seen the picture already. So let me just make a couple of final closing remarks on the quarter before handing over to Jan.

We are clearly conscious of the uncertainty in the global markets, but we still expect demand in Q4 to remain on about the same level as in Q3. We have, as I've noted, a couple of specific portfolio weaknesses they are being addressed in various way, including with the restructuring program that we now are launching.

Finally, the order book stands at SEK 37 billion. Obviously, a new record. You may even argue it's a bit too high, but nevertheless, it's a considerable order backlog into next year and demand continues to grow based on the sustainability agenda. So while we are dealing with our margin challenges in some specific business units, we continue to drive growth and capacity across most of the company also in the coming quarters.

And with that, I hand over to Jan.

[Jan Allde, executive]

Thank you, Tom. And as usual, I will start with the sales trend. So we expect the invoicing in Q3 to be higher than the same quarter last year. We realized sales of SEK 13.2 billion, which is 28% above last year. Please note that we had 3 acquisitions completed during the quarter, and together, we added approximately SEK 500 million or 5% to the sales bridge.

We also had a large positive FX translation impact on sales. Excluding both these impacts, the organic sales growth was 11.3% in Q3 versus last year.

With regards to sales in Q4 2022, my outlook is as follows. Considering the record high order backlog and a somewhat improved supply chain situation, I expect invoicing in Q4 to be higher than the same quarter last year on a comparable basis.

Then moving over to gross margin. So the gross profit margin in Q3 came in at 34.3% compared to 37.3% last year. We have seen a positive impact on margin from price increases coming through in a good way, especially in Energy and Marine -- Food & Water Division.

In Marine, on the other hand, we have margin pressure coming from both the order backlog with orders taken before 2022, a negative mix impact in capital sales, as well as a low factory load in BU pumping system due to the weak tanker market.

Finally, the acquisition of Desmet had a negative impact on gross profit margin of approximately 1%, considering the seasonal nature of the business with a large part of invoicing and profit coming in the later part of the year.

If we look into Q4, we expect the challenge in the Marine Division to continue. However, we do expect a general better delivery situation with higher invoicing coming through due to the gradually improving operating environment.

With regards to our S&A expenses, they were up 13% in Q3 versus last year on a comparable basis. This increase is reflecting the overall high business activity in the company, the inflationary pressure, but also that we are selectively adding resources in both our current businesses with high growth, but also some of our more long-term business development areas.

Compared to the first 9 months of 2019, prior to the breakout of COVID-19, our S&A expenses are up 6% year-to-date on a comparable basis despite the strong order growth and the high inflationary environment.

We do expect to gradually offset the higher S&A costs by increasing sales volumes as we execute on the large order backlog in the quarters to come.

As mentioned by Tom, we have initiated a restructuring program in parts of the Energy and Marine Division to address the known weaknesses in demand. The program includes a restructuring charge of approximately SEK 200 million that will be taken in Q4 2022 and includes a reduction of approximately 500 employees during '22 and '23, including the continued downsizing of our operations in Russia. Part of this will impact S&A resources, but the majority will impact costs.

With regards to the EBITDA margin, as you know, came in at 14.7% in the quarter, below last year due to the lower margin in the Marine Division, while the margin in Food & Water was slightly better than the previous quarter, excluding Desmet, and the margin in the Energy Division was very strong. Please note that the EBITDA margin for the group in Q3 was 15.5%, excluding Desmet.

Looking at some of the other key figures. So similar to S&A expenses, R&D expenses were up 14% versus last year on a comparable basis, again, reflecting the overall higher business activity in the company.

Net other cost and income increased by SEK 60 million versus last year. The increase is mainly explained by higher costs related to the ongoing changes to our manufacturing footprint and a onetime items positively impacting other income in Q3 of last year.

Financial net, excluding FX impact, was negative SEK 50 million in the quarter. The FX gains losses were negative SEK 65 million, giving a total finance net of negative SEK 105 million in Q3 versus a negative SEK 88 million last year. The tax rate was at 22.5% in the quarter and 25.1% year-to-date, slightly below our guidance of 26% for the full year. Net income and EPS was on approximately same level as last year.

Let me come to operating working capital. So working capital increased by SEK 1.3 billion in Q3, which is mainly due to an increase in inventories and trade receivables, partly offset by an increase in customer advances. The inventory increase has been driven by the strong order growth in combination with the fact that we are still operating in a challenging supply environment, including, for example, increasing level of semi-finished and finished goods inventory waiting for final delivery and invoice.

The picture that you see shows the development of operating working capital during the last 5 years, where the bars shows the absolute level of working capital. The blue line shows working capital in percent of order intake and the orange line shows working capital percent of invoicing. As you can see, the working capital in percent of invoicing has increased by some 4% to 5% during the last 2 years, while working capital in percent of orders are on the same level as 2022 -- sorry, 2020.

Hence, we have built up working capital along with the growth in orders, and we expect it gradually to come down as we execute on the record high order backlog and the supply situation stabilized.

So while looking at the cash flow, as I have commented on the working capital development in the prior picture, I will only mention a few additional things regarding the cash flow statement in Q3.

Cash flow from investing activities included payments of SEK 3.7 billion related to the 3 acquisitions completed in the quarter where, of course, the largest is the purchase price for Desmet of SEK 3.4 billion.

Secondly, our net debt-to-EBITDA position at the end of September or the net debt position at the end of September stands at SEK 13.2 billion with a net debt-to-EBITDA ratio of 1.5x.

On the FX side, the transaction FX effect on EBITDA in the quarter was a negative SEK 25 million, and the translation impact was positive SEK 145 million, giving a total net positive FX impact on EBITDA of SEK 120 million in the quarter.

Looking at the projection for full year, we expect a negative FX transaction impact of SEK 50 million. On the other hand, if the closing rate at the end of September remains, we would expect a positive translation impact that would more than offset the negative transaction impact for the full year. Regards to 2023, we see a potential large positive transaction effect related to the euro/U.S. dollar and the U.S./NOK currency pairs.

Then looking at the order backlog at the end of September stands at SEK 37.6 billion, which is 29% higher than at year-end 2021 on a comparable basis due to a positive book-to-bill ratio of 1.2 during the first 9 months of the year.

The acquisition of Desmet and Scanjet added SEK 5.7 billion total order backlog in the quarter. And the order backlog now represents 8 months of LTM sales on a comparable basis. For shipment in the remaining part of the year, the backlog amounts to SEK 11.9 billion, an increase of SEK 3.8 billion compared to the same time last year.

And then let's move on to the sales bridge. So starting with the sales of SEK 35.6 billion during the first 9 months of the year, and as stated in the previous slide, the backlog for shipment in the Q4 is SEK 11.9 billion, which gives or adds up to a subtotal of SEK 47.5 billion. On top of that, you will make your estimate on the change in price, in-for-out and FX effects. For your reference, the level in-for-out orders during Q4 of last year was SEK 3.6 billion. Finally, considering the project nature of Desmet, business level in-for-out orders in the quarter is very limited.

So by that, I hand back to Tom for further comments on the outlook.

[Tom Erixon, executive]

Thank you. And you already heard in general terms, our view going forward. While there are concerns about how the global economy will develop, we'll still see a healthy pipeline, and we expect order intake in all 3 divisions to be on about the same level as in Q3.

And with that, we are open for questions.

[Operator]

[Operator Instructions] We have the first question from Mattias Holmberg from DNB Markets.

[Mattias Holmberg, analyst]

Thanks for the comments on the Marine margin, which is where my question will be directed. It seems like the 10% or 11% margin reported in Q1 was sort of a low watermark based on the comments you made at that point, but this obviously wasn't the case. So I think it's really important to us to understand the drivers behind this soft margin, which you've helped us with already.

But I think if you could explain sort of how much of the deviation relates to, first, mix headwind from the ballast water and second, the weakness in the pumping system and then third, the mismatch between price and cost in the backlog would be very helpful.

[Tom Erixon, executive]

Yes. I don't think you're going to hear me talk about specific margin effects. But if you look and compare Q3 with the Q2, the main issue is related to cargo pumping in terms of mix change and utilization effects. On top of that, part of that decline is related to delayed order deliveries and EBITDA resulting mismatch of hedges. And so part of that was a one-off that may be recovered in the coming quarters.

So let's say, sometimes I make the comment that things are bad they're not necessarily as bad as they look, just as they're not always as good as they look when everything looks fine. So there are some aspects that come and go here, but it was -- the main driver was related to the cargo pumping business compared to Q2.

[Mattias Holmberg, analyst]

And a quick follow-up as well. The mix headwind from ballast water systems, you made a comment on sort of the phasing of how that should dissipate. Do you have any more granularity on that? Sort of are we talking 1 or 2 quarters or is it rather to the end of next year?

[Tom Erixon, executive]

I'm not sure what you are asking. If you're asking the mix change between ballast -- I give you the outlook on what is happening on the 2 environmental applications, the scrubber side and the ballast water side. The scrubber side went through its retrofit period quicker than anticipated, and it is today more of a new-build type of business than a continuation of the retrofit. So we don't expect that to come back in a meaningful way.

It is still, given a big price delta -- fuel delta in the market, there is still a pipeline of projects out there, and we are still active in that market. So there will be some demand coming and going. But largely, that is over time, turning into a service business where we will have a meaningful presence at reasonable profitability. But it will, obviously, not be anywhere near where we were at the peak.

In terms of the ballast water, we are starting to see the decline in the retrofit market as expected. It is happening now. We also are doing some adjustments to our capacity along those lines. So it's pretty much as expected. In that sense, the mix effect from the ballast water side is expected to decrease as part of the -- in terms of its share of it's -- of the Marine Division. So I hope that is sort of framing your question a bit.

[Operator]

The next question comes from Klas Bergelind from Citi.

[Klas Bergelind, analyst]

So my first question is on the cost program, the SEK 200 million that is spread across both Energy and Marine. I'm just trying to understand the program on the pumping system side better.

We know that contracting across the tanker spectrum is down 70% already. Orders are now improving from a low level, will take some time until this is impacting your P&L. But just to understand here, we get the structural takeout on Welded. Is this also a structural component on the Framo side or is it just because of this demand weakness? Because we hear of a quite solid product tanker outlook for the next couple of years from, obviously, a low level now. But if you could comment there, Tom.

[Tom Erixon, executive]

I think you are spot on. Number one, our cargo business and the Framo acquisition is a very strong company with a strong performance culture. So in terms of our restructuring program, we are trying to manage through a limited time of weaker demand, and we expect that, that will come back.

We are somewhat supported in this context by the fact that the offshore business is very, very strong as we can reallocate some people into other places. We are taking a cautious approach with respect to the organization in Bergen and the restructuring program. So I concur with your judgment on that.

The situation in business units, well, that was not new. We've been working with it for a couple of quarters. So it was not related to this quarter results in any way. We are partly gravitating in that unit from fossil dependency in applications towards others and some other structural changes.

And with effect of a relatively low CapEx cycle in the on land, refinery, petrochem side over a period of time, and then the cancellation of the Russian backlog that was done earlier this year, the utilization has been low. The structural change is there. And so we're addressing that.

So you don't necessarily see that in the Energy Division margin. But you can rest assure that we are running this company based on performance on all our units and not just a handful of them.

[Klas Bergelind, analyst]

My second one is on Desmet, and it seems like a more seasonal business more geared to the fourth quarter than we thought. And then you have acquisition-related costs, the dilution will be smaller into the fourth quarter you say. But could you comment on these acquisition-related costs, including the PPA effect? Because, I guess, they're quite big if I back it out or is the underlying margin investment lower than we thought? Obviously, yes, that has to do with the seasonality. But if I can get the underlying margin also in the quarter, that would be very helpful.

[Tom Erixon, executive]

Well, we gave you the guidance in connection with acquisition that you should expect Desmet to operate at approximately a double-digit level. So in order of magnitude of 10%, and we are not changing that guidance. So that is a yearly guidance. There is an aspect of how the results are managed in Desmet with a cautious accounting approach and leading to a relatively high profitability at the end of the year and a somewhat lower in the first 3 quarters.

And we saw -- so it was not necessarily only driven by a bit of a one-off cost and adjustments entering into the Alfa Laval structure, but also how the accounting is being done. We will review whether we prefer to have that sort of quarterly variations, it is somewhat of a difference compared to how we run our project engineering business that we already had in Food Systems.

And for your reference, maybe you don't work with that, we are in that business in the quarter, clearly above 10%. So we are very comfortable as to where we are in our engineering business as a whole and with Desmet. That's what I'm saying that you should expect there, clearly, a smaller impact on dilution in the fourth quarter. And we may be back to you in the Capital Markets Day or latest in the Q4 report as to how you should address this question in terms of forecasting for next year. But the overall yearly guidance remains what it was when -- there's no bad news following the acquisitions, we are on line with the plan.

[Klas Bergelind, analyst]

My quick, very final one is on Marine, and thinking about your sweet spot, as you talked a lot about before in terms of the content per vessel. Let's say, compared to 5 years ago, Tom, is it 10%, 20% or even maybe 50% higher in certain categories?

And also on LNG, this is a strong segment where contracting has been strong. It feels like you're yet to see the order growth in some of the stronger categories impacting positively more like in 2023. So yes, if you could comment on that.

[Tom Erixon, executive]

I think we are -- I mean, we may get back to you at the Capital Markets Day in terms of -- because this is a changing picture and not quarter-by-quarter, but certainly year-by-year in terms of how we build the program and how the specifications on the contracted ships are changing over time.

We see, I would say, overall, if you leave the specific issue of the cargo pumping a little bit on the side, the overall sweet spot and mix has been relatively stable for us in terms of where our sweet spots are versus the dry bulk and other segments that is perhaps less of an opportunity for us.

It's fair to say that our scope on any given ship is up with double-digit based on our offering, based on fuel and equipment decisions made by ship owners at this point in time. And as we indicated a number of times, the multi-fuel solutions is one of the aspects that is supporting the order volume per ship. So I think we are pleased with where we are.

I think with the contracted volumes that are there, although LNG, as you rightly point out, is a strong segment, I think is our expectations in our order intake versus how the mix looks like is quite in line with where we think it should be.

[Operator]

The next question comes from Max Yates from Morgan Stanley.

[Max Yates, analyst]

Just my first question is around price cost. And obviously, we've had -- as we've gone through this year, we've had the raw materials, then we've had sort of freights, and now we've got wages.

And I guess what I wanted to understand was, as we go into next year and you look at the sort of price increases that you're putting through today, do those already reflect say, 7%, 8% wage inflation that we're likely to see when you're delivering the contracts that you're taking today kind of in 12 or 15 months' time?

I'm just trying to understand kind of it's very difficult, clearly, in this environment to get ahead of this stuff. But how are you managing that when you think about pricing today?

[Tom Erixon, executive]

Yes, it's a good question. Let me just reflect on where we feel we are at this moment and then I'll try to make some reflections in going into next. I think if you look at our Energy Division as a whole and if you look at the Food & Water Division as a whole, and if you look at essentially all our Marine business, excluding the long order book on the boiler side, we have managed the cost inflation pricing up until now in a reasonable and stable way.

So the margin pressure that you see on the Alfa Laval Group is not a general cost inflation margin. It is some specific structural and capacity imbalances in the group that needs to be resolved with the exception that we have been repricing and redesigning the boiler products so that we can return to an acceptable margin during the next year. And so our experience so far is okay.

Looking forward into next year, we are making our standard cost assumptions pretty much around now when it comes to all of the input variables and we set the standup cost, that is the basis for gross margin calculations and the pricing.

I don't want to go into detail as to how that looks. But you're right in -- that we are expecting a somewhat higher salary and wage inflation than we have been having historically whether we are exactly on your level or not, let's leave that design, but we are also clearly aware that we need to work with productivity as an aspect in compensating for cost increases. We've always done, so we will continue to do that into next year.

The commodity prices are likely to be lower in dollar. But of course, the dollar strength is clouding a little bit the impact on the commodity prices. So given strong dollar and still reasonably high commodity prices, actually, those remain on a somewhat of an elevated level.

The energy cost doesn't hugely affect us. But clearly, with the somewhat European dependency in our supply chain, we are a bit exposed to that. I'm not alarmed by the situation. I think it's maybe over ventilated as a large issue for the industrial sphere. But of course, it is not a positive cost reduction opportunity going into next year. We will muddle through. So my feeling is we are much better balanced in the way input cost looks like and expectations look like into next year than we were this year.

The moving parts were more complex, unpredictable than they appear to be going into next year. So I'm a bit more comfortable as to how we manage gross margin and pricing levels for 2023 than I was for 2022. That's sort of my words around your question, I hope.

[Max Yates, analyst]

And maybe just a quick follow-up. I mean, the margin, obviously, that looks very strong within this set of results is still Energy, which is up a lot year-over-year and up a lot in the first 9 months. So I guess I just really want to -- just to double check here, kind of is there anything in this that is exceptional. If we think about sort of sales flat to slightly up next year in this division, is there any reason we would see a normalization in this margin? Or would you put this more down to mix of revenue, some of it? I think you've sort of more recently said that the kind of HVAC and refrigeration is higher margin than Energy now. So just framing that margin and whether there's anything we should -- we need to think about in terms of the actual absolute level that's being achieved here?

[Tom Erixon, executive]

I'm cautious as to predict strong margins going forward. We'll have to take it quarter-by-quarter. I think I sometimes make comments as to structural changes in the portfolio and how we see that impacting the, let's say, the underlying profitability in the Food Division throughout the year. That comment has mainly centered around a reduction of cost of quality and a better claim situations in the group, and that has had a structural meaningful impact on the result.

I think if we look at the Energy Division, my reflection on that would be that if we go back to 2015, when we had a huge oil and gas peak and a huge contribution and mix in favorable of the fossil fuel side, that turned into, let's say, a negative part of the mix going from 2016, '17, '18.

And we are now quite far in the energy transition from fossil dependencies in part of our product areas into the renewable side and energy efficiency side, and that in itself is a positive mix aspect for us. And I think that is structural compared to a couple of years ago. And as I indicated, we are trying to resolve the business unit Welded, which still is not delivering in line with our group targets. And so we have some way to go there. We may have some headwinds in other areas, but that's my language around how the cockpit looks like in the Energy Division.

[Max Yates, analyst]

And maybe just a very quick final one on net debt to EBITDA. So you're at 1.5x currently post the acquisitions. I guess I wanted to understand how you think about that level in relation to possible future M&A or further buybacks? Is there a level you have in mind that you'd like to get that to before you would consider doing more M&A and buybacks? Or just how you think about capital allocation in that context?

[Tom Erixon, executive]

I think the key point right now where we are is that we have to ensure that we work down the working capital, which has been -- is on an elevated level, and we know why. So the priority one is to work that down back to where it should be. And I kind of indicated that in my graph. So I would say, even though it's running now around 1.5x on net debt to EBITDA, we would expect that to come down to, let's say, closer to 1x. And then I think we would look at the situation. But I don't think we would return to initiate the share buyback program anytime soon.

[Operator]

The next question comes from Daniela Costa from Goldman Sachs.

[Daniela Costa, analyst]

I have 3 things, some follow-ups. But first, in case I missed it, I wondered if you comment on the savings amount that you expect precisely to generate from the restructuring. And if there's any way to split it between the divisions.

And the second thing I wanted to ask you following up on uses of cash on your CapEx increase that you had announced on the last CMD and whether you would think of reducing that given sort of like current macroenvironment and other things.

And then a final thing, just a follow-up on all the debate around mix impact in sides. In this case, it was pumping systems, I guess, that we were a bit surprised by how big the mix impact is. But when you look through your 3 main businesses, what is the sort of level of dispersions that you have on? Is it very wide, are some -- in some divisions like the different product sets more comparable, but just to gauge where could we have this type of surprises in the future?

[Tom Erixon, executive]

All right. Let's see. Let's take the first one, the restructuring. We have not communicated a detailed number yet. I expect that we will return at the Capital Markets Day or latest in connection with the Q4 report in terms of how we look at that program.

I think what is important to communicate is that this is not a program for execution next year. This is something -- it's not a program that is launched based on a weak Q3 margin. It is related to situations and capacity imbalances that we've been aware of and been anticipating throughout this year. So we are quite quickly into the program and then part of the execution is ongoing as we speak. So you should expect perhaps somewhat a unusually frontloaded situation on that part. Let us come back as you comment on that.

The other aspect, if I take your third question that you should be aware of is that, this number is not a net number. It's a gross number for those areas that we need to effect. At the same time, you see the growth rate ongoing in a number of our areas. And so to the answer to your question is yes, we are continuing the investment programs more or less in line with the CapEx guidance we've been given.

We are expecting to come in a bit below our CapEx guidance for this year. We will return on Capital Markets Day with an update on where we think it will be next year. But the situation today is very much one foot at the break and one on the gas pedal in the sense that if you believe that the hydrogen infrastructure will be built out over the next 5 years, if you believe that the heat pump market in Europe will be implemented in order to decrease the dependency on natural gas, et cetera, et cetera. It's very difficult to combine that outlook with the downturn.

And I think we are in a situation where we will make sure that customer can rely on our delivery capability and our CapEx program to follow them in their growth trajectory. And so we really have a mix of situations across the company that we are trying to deal with in a good way.

We are currently not prepared to go back on our growth programs in anticipation of a more difficult situation. We will obviously be prepared to slow down or adjust if needed. But I think the core -- what you probably will see in terms of CapEx is a concentration of capital allocation and resources to the core strategic growth CapEx, and we probably will run down maintenance CapEx and other aspects to be a bit receptive to the fact that the risk level in terms of growth and capital allocation has increased somewhat. So it's a trade-up decision that we need to make and I think we are clear on how we want to go about it.

Then your final question on mix is a good one. I think what we are seeing with respect to the cargo pump aspects versus others is somewhat of a bigger mix effect than we typically would have in any of the divisions.

The one that I've been pointing to before and you should be aware of, of course, is that our engineering business now represent with the acquisition of Desmet and our Food Systems engineering business, that amounts to somewhere between EUR 650 million, EUR 700 million within the Food Division and at a double-digit margin plus, of course, the mix impact on how much do we do on engineering projects versus components and system sales, that is a mix effect in the Food & Water Division.

And that's why we had a structural effect of this mix, although it was a bit elevated or looked a bit too aggressive, specifically in the quarter. And as I indicated to you, other than that the Food & Water Division margin was at normal levels of 16.8%. So that's probably the main one.

In the Energy Division, you can conclude that one out of 4 units is not delivering its needed performance, and we still manage the divisional margins on a good level. So you have one out of 4 cause that you may assume either it's going to remain a bit of a problem and -- or there is an upside in terms of us being able to turn it around.

[Operator]

The next question is from Sebastian Kuenne from RBC.

[Sebastian Kuenne, analyst]

I have a follow-up question on the sudden margin drop in Marine, the 500 bps. Could you maybe give us some kind of a split where you would say, okay, this is due to Framo, this is due to particularly low margin deliveries, this is due to raw material energy or the timing of pricing cost. Can you give us a split of why we see this sudden drop? I think this was not yet explained very well. That would be my first question.

[Tom Erixon, executive]

I think we've been unusually transparent as to the components. I think that we've been unusually transparent in saying that the main difference sequentially between Q2 and Q3 is a Framo effect. If you would have preferred us to announce this a quarter ago, number one, the in-for-out then the contracting in this area is quite sudden. We are sometimes sits with bigger orders before those are even seen in the clock some forecasts.

So we don't typically guide you on a plus and minuses ahead of time when it comes to margins. So -- but what we did discuss even at the last quarter report was that the contracting level for product tankers has been low and was low and some -- one of you guys asked the question, and we answered it correct at the time.

So it is what it is. I can't give you a clear answer as to how the comeback will be. All I can say is September saw somewhat better contracting, whether that is a trend or whether it will take some time and whether the slots are available short-term to drive the product volumes into production early, it's a little bit difficult to predict.

We are where we are and the effects were, as I indicated, quite big in the quarter. But I think that's the guidance I can give you.

[Sebastian Kuenne, analyst]

And then how much of that performance in Marine and in the margin was a surprise to you that evolved during the Q3? I mean, you just indicated that you had kind of an idea that Framo might not deliver very well in Q3, but how much of that was a surprise to you? Or did you already say, okay, this is not going to be a strong Q3. This is in our budget, these are the deliveries. So was that already kind of in your understanding or was there something popping up more lately? Because we had companies reporting on extreme energy cost increases. Was that a big concern or it does not?

[Tom Erixon, executive]

No, there is no other factor then if orders come in and will load production, then we see less of an effect and if we don't load it, so it's a very binary question. And so surprised or not surprised, the monthly order intake is always a surprise in all parts of the business. And in this one, it tends to be a little bit binary. So we see strong quarters and weak quarters. The thing that is different in this situation specifically is that we had a number of weak quarters based on exceptionally historically low contracting volumes at the shipyards. And eventually, we are running out a little bit of the backlog.

So that's why the financial consequences in the quarter is bigger than what you normally see. But in terms of the actual order intake volatility between quarters and months, that is normal to us.

[Sebastian Kuenne, analyst]

Yes. Final question. At what capacity do you run Framo at this point in time? And given that there's not much tanker orders coming through, tanker market is terrible still. How long do you plan to run Framo at that low utilization?

[Tom Erixon, executive]

I'm not going to give you a capacity number. It's clear that we're going at low capacity utilization in the cargo side, we got the high capacity utilization in the offshore that doesn't fully compensate, but it helps.

The question on -- the difficulty in giving you a production is not -- prediction is not just related to arrogance and not willing to communicate. What we can't know for sure is what lead times new orders will be booked with, and that's just an intransparency in the market. And I rather refrain from guesstimating this at the moment in time.

All I can say is we saw somewhat better situation in September than previously in the year. Whether that is a trend, I refrain to guess. And what will come in and decide the short-term in the next couple of quarters is going to depend on which slots at the yards are being booked. If they are reasonably near-term, it will support the situation quite short-term. But if it will be longer delivery times, then the effect with be lingering with us for a couple of quarters. So I would -- if I were you, I'd take a somewhat cautious approach to the next few quarters, and then we will update you as we go forward.

[Operator]

The next question is from James Moore from Redburn.

[James Moore, analyst]

I've got a few questions. One is on the relationship between your orders and the general industrial macroenvironment. And you hopefully said you're not seeing any signs in your end markets so far. But if we look back over the last 20, 25 years, you've often seen orders in all 3 of your business have some relationship to the macro picture. And if we were to see an industrial downturn in '23, I wondered if you could just talk about how you see your current sensitivity to those industrial trends at the moment?

The second one is on pumping systems. I wondered if you could give us a flavor for where the pumping systems margin was in the quarter. I'm really trying to understand the potential if you recover it and where you think it could get to and whether we should think about it being in the same sort of position for a quarter or so or whether it can recover more quickly than that?

And finally, my last question is on price cost in the backlog. I mean, you talked a bit about having executed some of the negative net price costs in the backlog, but still having some more to go. I wondered if you could size the impact has had to Group margins and how long you see that as a challenge?

[Tom Erixon, executive]

Quantifying is not my favorite topic. We try to give the numbers that we are comfortable in giving. But let me just say that, on the macro versus us, of course, you're right, and I'm certainly not going to put Alfa Laval in the position of declaring recession proof. I expect that there will be impacts as we see and if we see this economic decline continuing down.

Now there are 2 factors that are a little bit different for us if we look at the scenario going forward. The first one is, even if demand drops 10%, 15%, it means that the demand drop would approximately approach our level of invoicing. That is we have never been able to catch up in terms of activity and manning and capacity to the existing demand situation. And in fact, had we been at shorter lead times and at higher capacity, our order intake would have been even higher than it is today.

So we're already in a discrepancy versus underlying demand. And that first hit is going to be taken by just aligning invoicing levels at current level with the underlying demand.

If we look at any reasonable scenario above and beyond that, with the normal assumptions that the Service business remain a bit more steady and there are some other parts of the division of that amount. So fluctuating taking another 10%, which means a 20% down on the total thing and -- well, 35%, 40% decline in capital sales. Even if you go to that scenario, it's just an adjustment of 10% versus the top line today.

So we feel we are in pretty normal territory when -- if it should come to a situation where we need to adjust to a completely different business scenario. So that is, let's say, for contingency planning.

The other aspect that I was on to before is that if we are going to continue anywhere close to the Paris Agreement targets when it comes to the changes in energy mix, changes in energy efficiency and saving in energy consumption in order to alleviate the situation, it's difficult to combine that with a downturn. And so there are balancing factors. I'm not betting the whole scenario on that political stability will ensure that we are moving according to the environmental targets. But I think it is a factor in how to judge the cyclicality over the next cycle.

So it's on top of mind, the impact as we see it right now is limited. The impact in next year should it come to that, is potentially somewhat softer in terms of our industrial systems and our capacity adjustment than normally. That's my leverage around that.

[James Moore, analyst]

Are you able to give us a flavor for pumping systems profitability? I mean, is it a low single-digit margin or a heavy loss maker? I'm just trying to understand what it could mean when you return it to normal profitability?

[Tom Erixon, executive]

Well, there's nothing structurally that's changed in terms of that. So it's a pure volume number. If we have the contracting we need, we are back to normal.

[Operator]

The next question is from Lars Brorson from Barclays.

[Lars Brorson, analyst]

Tom, I was going to try and follow-up on that actually around the Framo development. Maybe firstly, if I can, Tom, what is driving the shift in deliveries? It sounds like it's really around slots at the yards. At the same time, it doesn't sound like you've got a huge amount of conviction that comes through in the next couple of quarters. So maybe just to clarify what is really sort of driving this, so you say, lack of invoicing in the quarter. If I can second that also to the restructuring program, I appreciate you won't give us details around the marine specifics of that. But what's your assumption behind the restructuring plan? Is there a risk here that, you would say, slightly more positive tanker outlook means that you don't take the necessary measures in the short-term?

And I'm curious also how much you can offset by reallocating to offshore pumping? What's the operational overlap here between marine pumping systems and the offshore bit?

[Tom Erixon, executive]

Let's see. If I start from the back, there is essentially no overlap between the 2 Framo businesses of offshore. However, the manufacturing sites are relatively close to each other, and we are able to transfer and safeguard all of our competence base by moving between the units. So in that sense, it's very helpful.

I don't -- you would always have to adjust your restructuring according to the situation as is and your expectations going forward. And we have a great deal of respect for the business that we are running out of Bergen and the long-term dependency of fleet dollars on that business.

So we would make sure that we have the capacity to ramp up. The only thing we know is that this is a temporary decline. I can't give you the exact time line for how it will come back. But that's a small burden for us to carry versus the customer service and the dependencies and partnerships we have with our customers there. So I'm not particularly worried about that side. The other part of the restructuring is more structural in nature.

Obviously, there were implications from running down our Russian activities. Obviously, there are some implications in part of the product portfolio related to fossil. So these are -- we are well aligned in terms of how that process is moving.

And I feel comfortable in the situation when we are growing with -- organically with 30% that we still find opportunities to optimize productivity and manning with -- in the one of magnitude of 500, I think it's just somewhat unusual. And I think we are taking opportunity of doing the right thing here. So I feel good about the program.

[Lars Brorson, analyst]

You've been very clear about the strong performance culture at Framo. You don't clearly seem to be questioning the organizational or operational setup in the business. It's a business that has a huge amount of autonomy within the context of Alfa Laval, where integration has been very limited, you would say, at least operationally.

And I think we know now where visibility is very low, and very, very significant Norwegian cost base. I'm just clarifying that there isn't a rethink here in terms of what should be done to this business should you go into a more sustained downturn on the tanker side?

[Tom Erixon, executive]

No, I would say on the contrary, I think we have been adapting the risk of Alfa Laval more to the Framo business model, if you like. The autonomy that we have between 14 operating units in the group is what allows us to, on the one hand, reduce manning and capacities in the 3 of our units and one of our sales companies to the order of magnitude of 500 to 600. And on the hand, grow with double-digits and 20%, 25% in other areas where we are a big CapEx program. So I think our flexibility and agility in a very complex operating environment is the key forward.

I recognize that you would have preferred to see a better financial performance in the quarter. But I think that the fact that we are where we are and is as good as it is, and we manage the growth combined with trying to deal with the problems is completely related to more decentralized decision-making and business unit profitability targets are measuring than we had before. So no, we are not going to restrict the operational freedom of our Norwegian friends.

[Lars Brorson, analyst]

Can I try 2 quick fire before I hand it over, please. Number one, on ballast water treatment. Historically, we've talked about margins there before royalty payments being on a par with Marine that was last year in the mid-teens. Is that still the case? Number one.

And number 2, just on Desmet, I think we've all been a bit fooled perhaps by the seasonality in that business. That seasonal margin profile, where you've got a fourth quarter is about half of the full year invoicing. Is that a business where, again, the first 3 quarters are low single or breakeven and then a high teens margin quarter on an underlying pre-PA basis. Is that the right way to think about it?

[Tom Erixon, executive]

Yes, you're kind of right. And we will guide you appropriately as we move into next year as to whether we make some modifications to that or not. But that was just important for me to make the point that we're not changing the yearly guidance. I understand that the FX was a bit bigger than anticipated in the quarter and expect something slightly more decent in the fourth quarter. That was in this matter. Sorry, the other part was?

[Lars Brorson, analyst]

Just on ballast water treatment, if we can, on balance margin?

[Tom Erixon, executive]

There is no real underlying change. What is happening in the market is that we're going to less retrofit and more new build in the mix, and that is somewhat negative on the margin. On the other hand, we start to see the service margins and service business coming in as a balancing factor. So I don't think structurally, we're going to see a big change on the guidance that the ballast water business is yielding somewhat above the group performance level before splitting the profits.

[Operator]

Ladies and gentlemen, due to the time, we have to stop the Q&A session now, and I hand back to Tom for closing comment.

[Tom Erixon, executive]

Thank you. And it's obviously was a good time to discuss part of the development. We will continue to do so on the Capital Markets Day in Copenhagen. If you have not noticed, that will actually be a very good opportunity to get acquainted with some of the development projects that we are running across the board in the group. So we are very excited about hosting you on site in Copenhagen at the Food & Water Engineering Center, I think you will enjoy. So I hope you can join us.

And then my final comment would just be to extend my thanks and gratitude to Jan. This is the last quarterly report with Jan. And at the next month and in connection with the Capital Markets, you will meet Jan successor, Fredrik Ekstrom, who has been running our heat pump related heat exchanger business for many years, and he's returning to the financial field after many years in business control. And we wish him welcome, and you will, as I said, meet him at the Capital Markets Day. So thank you, Jan, for 5 years of great service.

[Jan Allde, executive]

Thank you, Tom.

[Operator]

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.