Epiroc AB

STO:EPI A

Earnings Call Analysis

Executive Overview of Q4 Outlook and Performance

The company maintains an asset-light model with one foundry. Construction demand remained soft in Q3 and is expected to stay at similar levels in Q4. Foreign exchange (FX) impacts are uncertain, as the transaction part is more volatile than the translation part. However, given the historical weakness of the koruna, major FX translation impacts are not anticipated for Q4 unless there are significant currency fluctuations.

Elevated Order Intake Amidst Economic Adjustments

The company has experienced a significant 16% increase in orders, reaching SEK 11.3 billion, signaling robust demand, especially for equipment which saw a 14% organic increase. However, factoring Russia out of the equation shows a slight 1% organic decline. The service sector continues its upward trend with a 5% organic growth. Noteworthy is the strong showing in the Tools & Attachment segment, with a 17% surge in orders and a 2% organic rise. Orders for large equipment held steady with the previous year. This indicates a healthy investment sentiment among customers despite geopolitical tensions.

Challenging Profit Margins and Tax Hurdles

The company's profitability encountered headwinds with a 6% dip in operating profit, settling at SEK 481 million, accompanied by a contraction in the adjusted operating margin from 19.4% down to 15.1%. The effective tax rate saw a modest uptick to 23.4%, albeit within the forecast range of 22% to 24%. These financial metrics underscore pressures on profit margins, albeit still maintaining guidance on tax rates.

Cash Flow and Working Capital Dynamics

Cash flow performance registered improvements, and the company anticipates enhanced cash conversion moving forward. The working capital, adjusted for acquisitions and currency fluctuations, showed a 25% increase. Inventory and receivables have expanded, in part due to shipping constraints and regional distribution center setups affecting equipment delivery logistics. The company expressed commitment to stringent inventory management amid these supply challenges.

Stable Yet Sector-Specific Demand Projections

Looking ahead, mining equipment and aftermarket demand is anticipated to stay robust, contrasting with an expected softness in construction demand. The statement highlights ongoing demand patterns rather than representing a prospective order level change for Epiroc specifically.

Operational Challenges and Strategic Maneuvers

Operational bottlenecks, particularly outside of production lines in customer center workshops, were identified, influencing delivery timelines and inventory levels. These are expected to improve over the next two quarters, resolving timing-related revenue recognition and working capital concerns.

The Landscape of Equipment Orders

Despite a moderate Q3, the firm hasn't observed speculative equipment orders within the mining industry, signaling genuine demand for replacements and expansions. Intriguingly, large orders in the quarter did not include battery-electric vehicles (BEVs), with the focus on smaller, repeat orders as a barometer for the industry's gradual transition towards electrification.

Evolving Currency Impact and Cost Management

Foreign exchange continues to play a part in financial outcomes, with the interplay between translation and transaction impacts making future margin contributions unpredictable. However, Q3 saw positive effects predominantly from the transaction side. On the margin dilution front, the bulk stems from product mix and manufacturing absorption within the Tools & Attachment segment, while R&D and marketing adjustments offer an easier cost management route.

Electric and Battery Services Adoption

Although quarterly specifics are not disclosed, the uptake of electric and battery services is on a positive trajectory. The company emphasizes the significance of consistent, smaller orders from customers who have tried and tested the technology, viewing this as more indicative of the industry's transformation than isolated large orders.

Earnings Call Transcript 2023-Q3

[Karin Larsson, executive]

Hello, and a warm welcome to the Epiroc Q3 results presentation. My name is Karin Larsson, Head of Investor and Media Relations here at Epiroc. As always, when we present the results, I have the pleasure to stand here with Helena Hedblom, our CEO; and Hakan Folin, our CFO. They will briefly present the results before we host a shorter Q&A session.Helena, please, the stage is yours.

[Helena Hedblom, executive]

So thank you, Karin. So hello, and a warm welcome from my side as well. So let me jump straight into the quarter. As anticipated, the demand in the third quarter was seasonally weaker than in the previous quarter. The demand and activity level remained high within mining and several large mining equipment orders were won. Construction customers, on the other hand, remained hesitant and tentative. So within mining, it was a particularly strong demand for automation and connectivity solutions, both for acquired solutions as well as for our own solutions. So in total, our orders increased 17% year-on-year to SEK 14.4 billion.In September, we announced our largest-ever order, SEK 700 million to provide Kamoa Copper in Democratic Republic of the Congo with underground equipment. So after several years with local presence and highly skilled and committed service technicians on site, the collaboration between Epiroc and Kamoa Copper has deepened into a real productivity and sustainability partnership. And it's especially exciting to contribute to the success of the Kamoa-Kakula Copper Mining Complex, as it is projected to be among the world's lowest greenhouse gas-emitting copper mines per unit of metal produced.Our revenues increased 17% to SEK 15 billion, driven both by acquisitions and the organic development. And our operating margin, EBIT increased sequentially versus last quarter but decreased year-on-year. It was supported by currency, but acquisitions under absorption, investments in R&D and marketing as well as product mix impacted negatively. And Hakan will elaborate more on the margin later, but I can assure you that we are taking measures where needed while continuing to invest to remain a technology leader also in the future.So with more advanced technology, automation, digitalization and electrification, it is more likely that we at Epiroc, will also perform the service on the equipment, and this drives both revenues and profit, but the increasing number of service technicians in the field comes with a great responsibility. We must continue to make sure all our employees always act with safety in mind. And several actions have been taken to reduce injuries and we have a positive trend in the development of our safety indicators. But that said, I'm very sad to share that we have lost a service employee in a fatal accident in the quarter. Safety is our top priority, and it is crucial that all Epiroc employees come home safe and sound after the working day.In my next slide, I would like to speak about that partnership is the new leadership. So this is something that I truly believe in. And the order I just mentioned from Kamoa Copper is one good example, but there are more good examples like our partnership with Newcrest, one of the world's largest gold mining companies. In 2021, we announced that we created a semi-autonomous production level in the Cadia mine, and this project with mixed fleet equipment is developing well. And in this quarter, we now take our collaboration even further. So we will now take a holistic approach towards the entire mining processes at several Newcrest mines, supported by Epiroc's leading portfolio of automation, digitalization and electrification solutions. So in short, it means that we share a vision on how to make the whole mining process more efficient, and we will together invest to finding the best solutions to do so.Another collaboration we are engaged in is with Boliden and Algorix and Orebro University. And the project includes the creation of a digital twin of a mine, a simulated testing environment for artificial machine learning, which greatly reduces the need for physical testing. And speaking of reducing the need for physical interaction, to remember our Automatic Bit Changer, which enables hand-free bit changes and enhances productivity and safety by eliminating human interaction with the drill string. So following the very positive customer feedback, we have now extended this solution to include a wider fleet of Pit Vipers. So please let me share a short video on the Automatic Bit Changer.[Presentation]So as a short refresher, I would like to remind you of our strategy. So we focus on attractive niches and outperformance. And the way forward is defined by innovation, aftermarket and operational excellence, all of which rely on a foundation of a strong company culture and sustainability mindset. So innovation is to a large extent already covered today when I spoke about us being a productivity and sustainability partner to our customers.And now I would like to cover the aftermarket, another very important part of our business. So it represents roughly 70% of our revenues in the quarter and includes service and tools and attachments. And within service, we see continued high activity, especially in mining. With an aging fleet around 8.5 years on average, we also see a strong demand for parts and for rebuilds. For Tools & Attachment, the demand picture is more mixed. The largest portion of the revenues in Tools & Attachment is rock drilling tools, used both in mining and construction applications. And the demand there is good. The smaller but more profitable revenue stream is the hydraulic attachment. And here, we see a good demand for infrastructure projects while the construction demand within housing and aggregates is lower.Q1 and Q2 that are normally strong quarters for construction work were weaker this year and we see that the demand is still at low levels and we anticipate that the construction demand will remain weak.And this brings me to the next topic within our strategy, operational excellence. We have taken actions, and we will take more actions to improve our performance. So within production, we are adjusting to reduce under-absorption. We're also improving our manufacturing footprint, for example, moving production of low-profile machines from Orebro Sweden to Johannesburg in South Africa. On the admin side, we continue with the rollout of our regional centers of excellence for finance and HR to improve processes, efficiency and quality.So coming then over to sustainability, as I said, always safety first. And as I said in the beginning of the presentation today, I'm very sad to report a service employee fatality in Kazakhstan in the quarter, and we are working with the customers and local authorities to investigate the circumstances around the accident. On the safety metrics, we do, however, see improvements, and we have taken several actions to reduce injuries even further.On headcount, we are still growing. We are now a little bit more than 18,000 employees in our Epiroc family and we have continued to increase the proportion of women employees and women managers. We also have 1,800 additional employees that are also contributing to our progress. On emissions, we have managed to lower the CO2e emission from our operations for comparable units during the last 12 months with 26%, thanks to several initiatives, including installations of solar panels and a higher share of renewable electricity. And the CO2e emissions from transport has, however, increased somewhat, which is explained by higher volumes delivered. But as you all know, the emissions from us is mainly related to Scope 3, the use of products. So let me share an example of what our solutions can bring.In February this year, we finalized the acquisition of CR and that has widened our portfolio to also include GET system and GET is short for ground engagement tools. So with the right cast lip and GET system, customers can enjoy 10% more productivity while saving both energy and carbon emissions. So one bucket like you see in this example can reduce emissions by over 350 tons.So with this, Hakan, over to you to cover the financials.

[Hakan Folin, executive]

Okay. Thank you very much, Helena. So I will start with the key financials. And sequentially, our orders were down, which was anticipated as Q3 is normally a seasonally weaker quarter. But year-on-year, our orders received increased by 70% to SEK 14.4 billion, supported by acquisitions, they contributed with 7% and also by currency with 1%. The organic increase was 9%. But if we add back the removal of the Russian order book in Q3 2022, which was SEK 1 billion, we had a flat organic development. Customer activity remained high in mining. Several large equipment orders were won. Revenues also increased by 17% to SEK 15 billion and here, we had an organic growth of 7%. Acquisitions contributed strongly by 9%.Then a few words on our cash flow before discussing the margin on the next page. Our operating cash flow increased to SEK 1.9 billion. And if we compare to the same period in previous year, it was supported by higher operating profit, however, negatively impacted from net financial items and also higher taxes paid.Our operating profit, EBIT increased by 12% to SEK 3.3 billion. So it's up from SEK 2.9 billion last year. And I would argue that this is a meaningful increase. Items affecting comparability in this quarter were negative SEK 12 million, consisting mainly of the change in provision for our share-based long-term incentive program. The comparable period in previous year included a provision of SEK 150 million related to Russia.Looking at the adjusted operating margin, excluding the items affecting comparability, it came in at 21.8%, down from 23.9% last year, supported by currency, while acquisition, investment in R&D and marketing impacted negatively and also product mix and under-absorption in Tools & Attachment had an impact. And looking at acquisitions, more specifically, the dilution from them was 1.0 percentage points. As Helena said, we have taken and we will continue to take measures where needed within the organization to improve our profitability.If we then go into the segments and we start with Equipment & Service. Orders received increased by 16% to SEK 11.3 billion with an organic increase of 9%. And if we adjust for Russia again, orders were down 1% organically. For equipment specifically, the orders received amounted to SEK 4.5 billion, which corresponds to an organic increase of 14%, but if we adjust for Russia in equipment, orders were down 5% organically. Having said that, we still feel that the investment sentiment among our customers continued to be strong in the quarter and we won several large orders. In total, we won large orders of SEK 1.1 billion, including the 2 announced orders from Kamoa in DRC and also Byrnecut in Australia. Last year, in Q3, we had around SEK 1 billion in large orders, so we are more or less on the same level this year as we were last year.For our service business, orders received increased by 12% to SEK 6.8 billion, with a strong contribution from acquisitions. The organic growth was 5%, reflecting then a continued high activity level as well as a continued good demand for the large rebuilds that we do. And for service, if we adjust for Russia, service orders were up 3% organically. So our service business continues to perform strongly with a steady and solid organic growth.Operating profit for Equipment & Service was up 16% to SEK 2.9 billion. And here, higher revenues, currency and acquisition contributed to the development. The operating margin was 24.5%, almost flat compared to last year. But then again, last year, the margin was impacted by provisions related to Russia. And for this segment, it was SEK 138 million.If we look at adjusted operating margin, it was 24.4%, down from last year, 25.9% supported by currency. However, acquisitions impacted margin negatively, so did also the higher investment we're doing in R&D and sales activities. And within this segment, the dilution from acquisitions was 1.1 percentage points. And as you can see, the adjusted margin is slightly lower than the reported one. That is due to release from an M&A provision in previous year of SEK 7 million.If we then move on to Tools & Attachment, here, orders increased 17% to SEK 2.9 billion, up 2% organically, and acquisitions, and this is mainly CR, which Helena presented one of their products previously, contributed with 15%, while currency was flat. And if we adjust for Russia, orders here were down 1% organically. As we said before, the demand from the mining customer was good, but the demand from construction customers continued to be weak, and this impacts mainly the hydraulic attachment business negatively. Important markets such as Europe and U.S., they have a weaker housing and aggregates market. On the other hand, we see that infrastructure is holding up rather well. On the revenue side, they increased by 18% to SEK 3.2 billion, down 2% organically. Acquisition contributed with 19% and currency added another 1%.For Tools & Attachment, the operating profit was down 6% to SEK 481 million. The adjusted operating margin was 15.1%, down from 19.4% negatively impacted by lower revenues and under-absorption mainly in the hydraulic attachment business, and this, in turn, also impact the product mix negatively for this segment. Currency contributed positively to the margin, while structure had a small negative impact on the margin. However, if we look in absolute terms, structure, which include acquisitions then had a large positive impact. And in this segment, particularly, we have already taken some actions, and we will continue to focus on working smarter and more efficient going forward.Then moving on to the next slide, which is on cost, net financials and tax. As I said, we invest in our customer activities. We invest in R&D in order to generate business and develop state-of-the-art solutions for our customers. Having said that, cost control is for us equally important. And here, I believe that we can be more efficient on the cost side onwards, while we, at the same time, continue to invest in our business.Net financial items were SEK 331 million, negatively affected by the exchange rate difference and also net interest was up -- it was SEK 146 million, which is significantly higher than last year when it was only SEK 23 million, which is explained by our higher debt and also by the overall higher interest rates. On average, our rate has increased from 2.5% and we are now north of 4% and that makes a rather big difference.Income tax expense was SEK 685 million and the effective tax rate increased to 23.4% from 22% last year. However, this is still within the guided range we have of 22% to 24%.Moving on to operating cash flow, which has improved both sequentially but also year-on-year. On the positive side, we have a higher profit and we also have less working capital build-up than last year, but we have a negative impact from higher financial items, taxes paid and also investment. The cash conversion rate, which is calculated here on a rolling 12-month basis was 55%, which is an improvement compared to the last quarter. I think we can do better here and we do expect better cash flow and better cash conversion onwards.And let's elaborate a bit on the working capital side. Compared to last year, the net working capital have increased 29% and is now at SEK 23 billion. If we exclude the effect of acquisitions and currency, it has increased by 25%. And the increase, I would say, is mainly explained by a long period of strong growth, both in equipment and in service with corresponding higher level of inventories and receivables. And actually, a fairly meaningful portion of our inventory is equipment, either in transit or at our workshop out at our customer centers on the way to be delivered to our customers.And I mentioned the so-called RoRo capacity Roll on/Roll off within shipping. This is still an issue for us, and it limits our ability to get our equipment delivered to our customers. Our implementation of the regional distribution centers is ongoing. This ties up a meaningful portion of our spare part. It continues, but we are seeing an improvement in our ways of working here. And you can rest assured that inventory management is a very prioritized topic for us. When we look at the total average net working capital in relation to revenues and also here on a rolling 12-month basis, it was up to 34.8%.So finally for me, before I hand back to you, Helena, a few words on our working capital efficiency. We have a net debt position of SEK 7.6 billion. Last year, at this point, we were actually cash positive. So it's quite a big difference. And the main explanation is the acquisitions that we have made.If we look on the return on capital employed, we have been rather stable around 28% if you compare to last year. But if you compare to 2 years ago, we were at 25%, so quite a strong improvement since then.Okay. Over to you, Helena.

[Helena Hedblom, executive]

Thank you. So before speaking about the future then, I will briefly summarize this quarter. So safety is on the top of the agenda always and we will continue to educate and work on improving safety, both for us and for our customers. We had continued high demand in mining in the quarter and we landed several large orders, which is a result of a good long-term collaboration with customers. I truly believe that partnership is the new leadership.Construction was weak in the quarter, while Infrastructure had a stable development. We delivered strong revenues, up 17% year-on-year, including a good performance from our acquisitions. And onwards, we will continue to focus on operational excellence while protecting and gaining customer share. The operating cash flow improved both year-on-year and sequentially.And finally then, a few words on the near-term. So we expect that the underlying mining demand, both for equipment and aftermarket will remain at a high level and that the demand from construction customers is expected to be soft. And I would like to emphasize that this statement is referring to underlying demand trends and not absolute order levels for us at Epiroc.So thank you, and over to you, Karin.

[Karin Larsson, executive]

Thank you, Helena. Thank you, Hakan. So before starting the Q&A, I would just like to highlight the important dates for the next year. And especially, I would like all of you to mark your calendars for September '24 as we will host our CMD in Las Vegas in conjunction with the MINExpo, and that's the largest [ Mine Fair ] in the world.So operator, you may now open the line for questions. Thank you.

[Operator]

[Operator Instructions] The next question comes from John Kim from Deutsche Bank.

[John-B Kim, analyst]

Two questions, if I may. If we think about near term, call it, the next 2 to 3 years, how should we think about production levels and visibility given issues in key end markets like Chinese construction and perhaps electric vehicles? A more pointed question for the shorter term. Can you speak about what you're seeing in underlying demand dynamics within hydraulic attachments?

[Helena Hedblom, executive]

I think if we start with the second one there. So on hydraulic attachment, we see solid demand for the portion of the product that goes into mining as well as infrastructure projects, while the -- say, sub-segments that is more related to housing and aggregates, that's where we see lower demand. And if I look at it from a regional perspective, it's the same trend in U.S., the same trend in Europe as well as India, which are our main markets.I think on the -- did I understand you correctly that when you asked about, let's say, the activity levels, it was more related to construction also in China for the coming years? Was that the question?

[John-B Kim, analyst]

Perhaps a little bit different. I mean, both of your business is driven by mining and it offers a key exposure. You've had good orders recently. But when you look at kind of key end markets for copper consumption, we could argue construction and perhaps China as a key [ yields ] and that looks to be trending negative. I'm just wondering if you're seeing that feed through your part of the value chain.

[Helena Hedblom, executive]

I would say on copper, yes, I see what you are looking at there. But I think at the same time on copper, there are the supply/demand gap that is also -- will be there in the coming years, leading to that expansion projects will have to happen, also greenfield will have to happen to safeguard production output in the coming years. So I think that should also be taken into consideration when looking at the overall demand. As well as lower grades, I think copper is also the commodity where we see that the grades are going down.

[John-B Kim, analyst]

Does that give you a material advantage on pricing or utilization levels with the decline in copper grade?

[Helena Hedblom, executive]

Yes. And more complex, you need to go deeper, it's more complex ore bodies and that is good for us because that -- it's more advanced equipment needed, more safety aspects that you need to take into consideration with depth, et cetera. So I think there are -- the overall -- the underlying trends are making it more difficult to bring up the same amount of metals in the coming years. And here, of course, also our technology solutions helps our customers to do the business at a more difficult levels and more difficult environment.

[Operator]

The next question comes from Klas Bergelind from Citi.

[Klas Bergelind, analyst]

So my first one is on the underlying orders -- SEK 1.1 billion in large orders. The decline quarter-on-quarter ex-currency and M&A appears bigger than normal seasonality. And you say that the mining outlook is still solid, Helena, and you have indeed received obviously big orders. But just on the underlying side of this sort of near-term pushouts of order decisions because of higher funding costs or are we having sort of construction exposure also within E&S, not only within T&A that is sort of driving down orders a bit. If you could comment there, that would be very useful.

[Helena Hedblom, executive]

Yes. I would say that, that is the case. You are spot on. So we, of course, we also have equipment for construction applications and we see tunneling going strong, but at the same time, related the more smaller machines going towards housing and demolition and quarries, there we see a softer demand, not only on the attachment side, but also on equipment. But when I look at the underlying activity levels, when I look at the age of the fleet, when I look on the pipeline, it's still holding up well in mining.

[Klas Bergelind, analyst]

Good to hear. And when it comes to [indiscernible] and the drop-through in Equipment & Service, the organic drop-through is now negative in high-single digit sales, which is a bit unusual. You talked about R&D, SG&A under-absorption. But I'm trying to understand what kind of drop-through we should model going forward here the next couple of quarters? You're talking about potentially taking out cost to improve the leverage. Is this a short-term fix? Or do you think that this is sort of the level we should model here in the near term?

[Hakan Folin, executive]

No. I mean, we have -- since I started at least, almost every quarter showed a fairly good, solid flow through. And now this quarter was an exception and this is an area where we think that we can definitely do better. So no, we don't want you to model in that we're going to have negative flow-through in the years going forward. That's something we're not happy with that performance and we aim to do it better going forward. Then we're not going to guide you on a specific level of exactly what the flow-through will be. That was a difficult word saying. But we definitely think that we can do better than we did this quarter.

[Helena Hedblom, executive]

And just to be -- from my side as well, we are not happy with our efficiency in the quarter and we have already taken measures to improve and we will continue to do so.

[Klas Bergelind, analyst]

My final one for you Helena is on the service side, 3% growth in orders, say, the Russia comp. I guess you still have pricing in that. So volumes are perhaps down a bit. We've seen minor struggling with production with some pent-up production demand ahead in the next couple of quarters. But I'm curious on the rebuild, in the same way as we see the equipment pushouts, maybe not for you, but across the whole suppliers. Do you think there is a risk here that this can happen as well on the rebuild? So are you still seeing rebuilding relatively solid?

[Helena Hedblom, executive]

I would say rebuilds are solid. So I would say -- that I think I said the same last quarter, but with a big portion also or big portion, but a bigger portion of our service revenues coming from these service products and rebuilds, it can be a variation between the quarters. But when I look at how much we're landing when it comes to rebuilds, it's a very solid level. And I don't expect that to be -- to come down even if there would be pushouts and decision for equipment moving forward. I don't expect rebuilds to -- that will not follow the same logic because that's an operational decision. So very often, we have seen that, you do larger rebuilds actually when the activity levels are lower in mining because that's also when you can do it in an efficient way.

[Operator]

The next question comes from Max Yates from Morgan Stanley.

[Max Yates, analyst]

Could I just start on the Tools & Attachments margin and the changes that you're making. I think if I look back at sort of Q1 when you were last doing a 23% margin at group level, you were doing around 17% in the Tools & Attachments business. I guess my question is, how quickly would you expect assuming we're not getting a kind of big top line recovery anytime soon in tools and attachments, how quickly do you think the changes that you're making will get margins kind of back up to what, I guess, we would consider and maybe you would consider a more normalized level? Is that something that happens in a quarter? Or is that something that happens sort of going into 2024?

[Helena Hedblom, executive]

I wouldn't say in a quarter, but in a couple of quarters, then of course, this is -- it is a mix effect. So of course, to adjust operations is one thing, but there's also a product mix effect here. We have higher margins on our attachment business than on the traditional consumables business. So there will still be a mix effect, but I think the inefficiency that we have in the -- in [indiscernible] operations in this quarter due to the lower volumes that, of course, we're addressing and addressing quickly.

[Max Yates, analyst]

Okay. And maybe just a follow-up. Could you help us a little bit with the actual sort of revenue split of your Tools & Attachments business? And I guess you talked about kind of the rock drilling tools was good, hydraulic attachments was a little bit weaker in construction. And the other business, I was curious about given Sandvik's comments, they talked about their business sort of ground support for sort of steel bars holding up mines was seeing some quite negative price impact. How big would that business be for you? As I kind of had a look, and it does look like you have some exposure here? And are you also seeing sort of similar pricing trends where Sandvik talked about their pricing to be down about 10% in that business?

[Helena Hedblom, executive]

So if we start with the first question, we have not shared, you will see the exact split. But if I look on the total, the consumables business is the largest portion of TLD and the attachment business is the smaller one. So -- but we have not shared, I would say, the split between them. When it comes to rock reinforcement that is a small piece, and I don't see the same things happening on the pricing side. I think for -- we are very focused on deep mines with seismic activities, where you have special solutions and where you can sell value when it comes to rock reinforcement. So that's the, let's say, the offering we have towards rock reinforcement and that sub-segment.

[Hakan Folin, executive]

And if I may add, Helena, we also now have the fourth type of business within Tools & Attachments of the acquisition of CR, so the ground engagement tools as well.

[Max Yates, analyst]

And maybe just a real quick housekeeping question. I mean, just when you show that admin marketing and R&D expenses as a percentage of sales, and I look at it -- I look at it sort of year-over-year, it was 16% of sales in Q3 '22, it was 16.1% in Q2 '23, and it's 16.1% this year -- this quarter, I guess, that's not really much of a change. So should we sort of infer from that the actual size of the extra kind of investments on margin was maybe 10 basis points and actually, it was the other issues that were bigger? Or is there some investments that maybe aren't in this line? Could you help us size what the kind of impact was from that extra investment?

[Helena Hedblom, executive]

Well, I would say rather that with the growth we have, we expect to have efficiency in admin. That's part of our operational excellence initiative. We always drive for more efficiency on admin. So then, of course, we need that also to be able to continue to invest in product development and our presence. So for me, it's more that -- okay, we -- with the increase in revenue, of course, we expect admin efficiency, and we have not seen that to the level that we expected.

[Operator]

The next question comes from Ben Heelan from Bank of America.

[Benjamin Heelan, analyst]

Yes. I wanted to come back on the order points because you talked about hesitation and the orders do look as though they're slowing on the [ ARV ] side. And we've heard some comments from some of the big miners about the current interest rate environment. So to your answer of the question of -- a few questions ago, are you saying that on the mining side, you're just not really seeing any impact at all from the higher rate environment on investments in the sector and it's all about construction? Or are you seeing that? And it's just been benefited by some of these large orders? I'm a little bit confused about the commentary on the mining side of things?And then secondly, if I can, around pricing in general, are there any big changes that you're seeing from a pricing perspective across the business?

[Helena Hedblom, executive]

So we don't see hesitations among our mining customers. And I think what -- we landed several large orders, as Hakan said, in the quarter as well, above SEK 1 billion, which is -- that's a big chunk of large orders. And when I look at the pipeline as well, and I think this is -- but also we need to remember that there's also constantly a need for replacement and the fleet every year now has grown older. So of course, we come closer also to that replacement need. So I don't see that hesitation from the mining customers, but we see it on construction. So that's why we comment like this.On pricing, I have not -- we don't see any difference. We work with pricing always and it's always tied to our innovation and the value that we can create. So I wouldn't say that we see any -- we don't behave in a different way than we normally do.

[Hakan Folin, executive]

Where we have seen a hesitation, but that we mentioned already, I think, already in Q1 but definitely in Q2 is on the exploration side and then especially more for the junior exploration companies, there, we saw when interest rates started to go up, we started to see more hesitation.

[Benjamin Heelan, analyst]

And just a quick follow-up on that. You said that Q3 was seasonally one of your smaller quarters. Should we assume that then that Q4 sequentially should see an improvement from an order perspective? Is that how we should be thinking about the end of the year?

[Helena Hedblom, executive]

I think it's always -- it's -- it all depends on large orders as always, which is always lumpy. And so it's very difficult to predict when the large orders will come into the -- into our books. So I would -- when we comment, we comment on, we'd say the underlying activity levels, we cannot predict the large orders.

[Operator]

The next question comes from Gustaf Schwerin from Handelsbanken.

[Gustaf Schwerin, analyst]

Yes. I have a follow-up question on the leverage in Equipment & Service. So you have a similar share of service a year ago. You're mentioning the higher SG&A, R&D. Then I look at, for example, Q1 this year where you have a quite similar mix in Q3, quite similar organic growth even though a bit higher on the service side. At the same time, you have a larger increase in the costs year-over-year, but equipment and services posting 35% leverage in the quarter.So, I mean, I struggle a little bit to understand why we are at such a low level now. Is it only the higher cost base year-over-year and lower growth versus Q1? Or is there actually some kind of negative mix effect within service or anything else?

[Hakan Folin, executive]

No, I wouldn't really say there's a negative mix impact. I think coming back to what we talked a little bit about before is that we think that there are things also in Equipment & Service that we can do better than we did in this quarter. So not a really big mix impact. If you compare those to Q3 last year, a large portion of the change in the adjusted operating profit is coming from the dilution of acquisitions, where we have made a few acquisitions within this segment and also they are growing quite nicely as we showed with 9% contribution to the revenue. But most of them, I would argue them with a smaller -- lower margin and thereby diluting the overall profit. But no, no real mix impact within the service part.

[Gustaf Schwerin, analyst]

And then just secondly, on the equipment deliveries, they look a bit low. It is only up on logistics because I got the impression before that we will not have much of a seasonal effect on the leverage for Q3. So it's outbound the [indiscernible]?

[Helena Hedblom, executive]

It's outbound the RoRo capacity. But on top of that, we also have, say, bottlenecks right now in our local modification in our service centers doing the local modifications. And one example is Australia, for example. So we do the last modification from safety aspect in -- according to local legislation. And there, we have bottlenecks that we are addressing right now. But that has put, I would say, that has caused a problem when it comes to actually bringing -- because we are not happy with the output on equipment in the quarter.And if you -- output from factories, yes, but not the output in the last stage there. So that we are addressing as we speak as well.

[Gustaf Schwerin, analyst]

Just a follow-up on that, has that worsened quarter-on-quarter? Because I assume RoRo capacity is probably a big factor in Q3 versus Q2?

[Helena Hedblom, executive]

So this is more related to that these local modifications are competing with the same resources that we do rebuilds for -- in the service. So it's the same service workshops. So it's -- we have it in our own hands. And of course, it's more assemblers that is needed. So this is pure capacity within our own organization, not really related to the challenges we have had previously on -- of course, they're still challenged with the RoRo capacity on the outbound, but I'd say a big portion of why we have not really managed the output on the equipment in the quarter is that we have a bottleneck internally in our workshops out in the different customer centers and specifically, I would say, in Australia.

[Operator]

The next question comes from Christian Hinderaker from Goldman Sachs.

[Christian Hinderaker, analyst]

I just wanted to ask firstly on the margin headwinds, but maybe ask a little differently. You've cited marketing spend is one of the headwinds. I think that's been a little more than SEK 1 billion in the past 2 quarters, up around 28% year-on-year on sales growth of a similar number at around 30% this quarter. I'd assume that would have been from the return of travel spend and costs that coming back after COVID. But then if you look back to pre-COVID the average was more in the mid-600 levels in corona terms.I guess, not dissimilar actually as a percent of sales, though, looks a little bit shy of 7%. So just interested in what is driving that sequential and year-on-year pickup in marketing expense? How should we think about modeling that relative to sales? Should there be some efficiency as you expand the top line?

[Helena Hedblom, executive]

Yes. So I would say that it's mainly initiatives to improve. And of course, to -- it's both presence, it's to capture the future growth. But I think when we -- for this quarter, now we are not in line with from an efficiency standpoint. So there is clearly things we can do to improve efficiency in marketing as well and that we have already initiated that work. So it's -- I would say it's the traditional marketing and feet on the street, but also some larger projects that we have ongoing to understand and develop let's say, how to capture the future opportunities as well in certain parts of the world.

[Christian Hinderaker, analyst]

Can I come back on inventories then and specifically on the consumables side. I just wonder how we should think about your distribution model here. We know that you're moving to regional hubs. Can I ask what proportion of your customers are leaning on your balance sheet to hold their spare parts and requiring sort of 24/7 deliveries relative to the proportion that might opt for vendor managed inventory. And then what is your outlook for channel inventories in terms of consumables in mining? Could there be destocking? We've heard a mixed picture in that sense from the supplier peers this week. So I'd be interested in your thoughts.

[Helena Hedblom, executive]

So the setup we have is that we have created this regional distribution centers in the different parts of the region -- in the different parts of the world. With then -- and we have structured that network so that we can deliver both parts and consumers within 24 hours to the customers in that region. On top of that, of course, when we have a larger service contracts, we have consignment stock on the sites. So that's very much the model and that's how we are operating both within parts and service and consumables.When it comes to destocking, we see destocking happening within the infrastructure side. So I think a part of the lower demand there, it's lower activity, but it's partly also destocking. We don't see destocking in the mining space. That's not really the -- let's say, we have not seen anything like that within mining, but within construction and because there also we use indirect channels and with indirect channels, that challenge can be there over time.

[Christian Hinderaker, analyst]

And thirdly, maybe on the CR acquisition, you made that in the fourth quarter last year, and it was a focus of the case study, but also a driver of some of the acquisition dilution to the margin. Just wonder how that integration is progressing, what are your broader strategic ambitions here as well in terms of growing out the ground engaging tools product family? Is that organic only or inclusive of M&A? And how should we think about the vertical integration of this business? Because if I'm not mistaken, I think you have your own foundry that you've acquired now whereas the majority of the group is not vertically integrated to the same extent?

[Helena Hedblom, executive]

Yes. So we are very happy with the progress on the integration as well as on the synergies. So I think this is a very good fit with Epiroc. When we look at the CR business or ground engagement tools business, is very much the same as Tools & Attachments. It's a productivity offering, long contracts in the same way you sell it on TCO and you create contracts, 3-year up to 5-year contracts with our customers, which are very similar to the consumables business.So of course, our ambition now is to grow this organically, I would say, mainly. And on top of that also, there is a nice suite of digital products that came with the CR acquisition that also now we can incorporate in the overall digital solution offering that we have at Epiroc. So very pleased with that acquisition.When it comes to integration or vertical integration, yes, CR had one foundry, but that is a small portion of the actual total flow of these type of raw material into their business. Majority of the flow comes from external parts -- parties. And that's -- I think it's a very good model. And [ own ] foundry is crucial to be able to develop new steel grades and to make sure that you have the right quality, but also that you can lead from an innovation standpoint. But we don't have any, I would say, further ambition when it comes to vertical integration. We believe in this asset-light model. And I think the setup we see is a good fit from an asset-light perspective with one foundry and not more than that.

[Operator]

The next question comes from Andreas Koski from BNP Paribas Exane.

[Andreas Koski, analyst]

Three quick questions. Firstly, on your outlook, you are saying that you expect construction demand to be soft, but does that mean that you expect it to weaken further from the third quarter? Or did you consider the underlying demand in Q3 to be soft and we are going to see the same kind of underlying demand in the fourth quarter?

[Helena Hedblom, executive]

It's correct. So when we say soft, we already see it as soft. So not the same level as we have seen in Q3.

[Andreas Koski, analyst]

Okay. And then 2 questions just on the margin. Firstly, on the FX impact at current currency rates, do you see the same year-over-year margin support from FX in Q4? Or was the margin support in Q3, sort of a one-off effect?

[Hakan Folin, executive]

If I can answer that. In terms of FX, as you know, it depends both on the translation part, but also on the transaction part, where the transaction part can be a bit more lumpy in terms of its revaluation of especially AP and AR on the actually balance day. And in Q2, we had a quite negative margin impact. Now in Q3, we had a positive impact. If you look -- if you take year-to-date, it's actually -- it's a rather small impact. Looking into -- and now in this quarter, it was more on the transaction side rather than on the translation side. And again, the transaction side is more difficult to estimate what it's going to be on the actual balance day.But in terms of the translation part, as I mentioned, I believe, when I started presenting, since the corona has been fairly weak for a long time now, if there are no major changes, the translation part, we would expect to be fairly limited in Q4 than the transaction part, that might vary more.

[Andreas Koski, analyst]

Okay. And then on the 250 basis point organic margin dilution, how much would you say come from mix and under-absorption and how much come from R&D and marketing? The reason for asking is because I guess it's easier to adjust R&D and marketing than mix and under-absorption.

[Hakan Folin, executive]

I think you can look at the 2 segments here. And because if you look on group level, yes, we have lower margin and we have this negative organic. The main portion of that comes from the Tools & Attachment segments where, as we mentioned before, there, we both have the product mix and also we have the product mix given the lower sales of hydraulic attachment and also the under-absorption given that we have produced less.And I would add also, it's under-absorption not only because the sales volumes are lower, but it's also an effect that we are trying to reduce the inventory. So we have also adjusted production from that point of view. So the majority of that you can actually see in that segment, I think that hopefully explains.

[Operator]

The next question comes from Vlad Sergievskii from Barclays. [Operator Instructions] The next question comes from Anders Roslund from Pareto Securities.

[Anders Roslund, analyst]

Yes. I had just one question regarding the bottlenecks you mentioned here in production. It seems that you hardly grew at all volume-wise in the equipment area, given a 5% increase. And if you take away some price, it seems that there must be some bottlenecks. And that means also that you have higher inventory levels. How quick could you sort of address those issues? Could we see a better outflow in the fourth quarter and a better cash flow? Or is it a gradual process?

[Helena Hedblom, executive]

Yes. So it's -- the bottleneck is not really in the production lines that we have. The bottlenecks are out in the customer centers in the workshops where we do the final modifications, which means then that the machines are already in Australia or in Chile, which, of course, so you don't have the lead time. And that, of course, helps when we sort of managed to open up these bottlenecks, revenue will happen quicker. So it's not in the factories any longer. The challenge is out in the customer centers in certain markets.But I expect improvements in the coming 2 quarters, I would say. I cannot promise that we managed to do everything in one quarter. But over the coming 2 quarters, I think this one will be sorted out. So I would say it's a timing issue. But you're correct. This is also, of course, leading to that, we're tying more inventory than we want.

[Operator]

The next question comes from Anders Idborg from ABG Sundal Collier.

[Anders Idborg, analyst]

Just love to hear your thoughts. I mean, it seems to be the same way for all the mining equipment companies now orders for equipment are okay in Q3, but not at all at the same level as in Q1 and Q2. I mean, with the hindsight that we have now, do you think there -- given that lead times are coming down, do you think there was a bit of over-ordering still inflating the first half orders to something that was just not sustainable? Or do you think that sort of the step down now is more sort of junior miners, et cetera, are having issues with funding costs, et cetera, or a combination of the 2? I mean, what would be your thoughts on that?

[Helena Hedblom, executive]

I don't really -- on the equipment side, we seldom see customers do speculation orders. I wouldn't say that, that is maybe towards construction that could happen because there the contractors, they don't know if they will win or if they will lose something. And there, they can, of course, gamble with an order. Within mining, I wouldn't say that we will very seldom see speculation orders like that. We know our customers very well and it's either replacements or it is expansion. And again, when we look at the orders received, also in Q3, roughly half of the orders for equipment relates to replacement orders and roughly half relates to expansion orders and mainly then brownfield expansions.So I wouldn't say that there is an impact of -- that we saw pre-ordering earlier. I think it's more timing issues, and that will always be the case when it comes to equipment, when they press the button to actually do the investment.

[Anders Idborg, analyst]

Right. So maybe the equipment orders that we saw in the first half, I mean, those could very well be repeated once the market normalizes, et cetera?

[Helena Hedblom, executive]

Yes.

[Anders Idborg, analyst]

Okay. Just secondly, I'm not sure if you mentioned it, just an update on sort of the uptake of electric, uptake of battery as a service, all of that, what kind of proportion you have now of order intake as electrified? That would be useful.

[Helena Hedblom, executive]

So we have not yet shared the, say, the amount not per quarter, at least. We shared it in when we had the Capital Markets Day. But I would say that it's steadily improving. At the same time, it's fair to say the large orders, the customers that are -- that want to go for [Technical Difficulty] there another quarter. I think what is maybe more interesting is this customer is doing repeat orders, putting more orders in for 1, 2, 3 machines, et cetera, because that proves that they have tested it and they are convinced, it's lower numbers in total. We don't see these fantastic orders, and we had -- none of the large orders in the quarter were BEVs, but are more focused on this repetitive and smaller ones because I think that will be how you transform the industry, not just trusting these large orders and greenfield operations to go green.

[Karin Larsson, executive]

[Technical Difficulty] already due to end this call. Thank you, Hakan, Helena. I know we have a few analysts still on the line. We have your names, and we will reach out to you after this call to make sure you get your questions answered. But for now, we say thank you very much, everyone, for taking the time today. And as always, we wish all of you successful investments. Thank you.

[Helena Hedblom, executive]

Thank you.

[Hakan Folin, executive]

Thank you very much.