Volvo AB

STO:VOLV B

Earnings Call Transcript 2022-Q3

[Claes Eliasson, executive]

Ladies and gentlemen, a warm welcome to this present analyst meeting covering the third quarter 2022 by the Volvo Group. My name is Claes Eliasson, I'm the Senior Vice President, Media Relations. And today, we will be listening to our CEO, Martin Lundstedt; and our CFO, Tina Hultkvist.

So by that, Martin, I think the audience is eager to hear you take us through the quarter. So go ahead.

[Martin Lundstedt, executive]

Thank you, Claes. Thank you for that. And I have to start to say it's great to be back in Stockholm. It has been a couple of years now since we actually had a presentation here. So it's somewhat a sign that things are -- I should not say normalized because they are not, but anyhow, it's good to be here. So also welcome from my side.

Some comments before getting into the presentation here. In the third quarter, as you have seen also in the report, the group continued to deliver strong performance both from customer business, but also financial perspectives. We are very proud that we continue to pave the way for the transition into fossil-free transportation, a milestone that we will come back to, and a big milestone, I think, not only for the Volvo Group but also for the industry.

But maybe most significant, and I have to say I've been long in this industry, and most significant for me that we are continuing to live in extremely turbulent and uncertain times. And in that perspective, how the Volvo Group actually has been able to continue all the colleagues and business partners to do an outstanding job to master these really stormy waters and to produce and deliver as many products as possible to satisfy the still high demand of our customers and to materialize also on the strong order book. That has and will continue to be the main priority right now.

So if we take a look then on the quarterly highlights, we start with a strong top line growth that we have seen, of course, a currency tailwind, but despite that, also very strong grows up to SEK 115 billion, a 21% growth if we adjust for currency despite the continuous challenges and low visibility in the supply chain, both as regards capacity but also pressure due to accelerated cost for different input materials and not at least then energy and in particular the energy in Europe. The adjusted operating income amounted to a record high for a third quarter, SEK 11.9 billion, at a margin of 10.3%.

So both for sales and operating income, it was the best ever quarter 3 as we continued to push boundaries to realize our strong order backlog and to build population amongst our customers.

We also had, which is important in these times, a strong cash flow of almost SEK 15 billion. And all in all, it resulted in an improved return on capital employed that was north of 27% and an earning per share that also increased with 22%.

We continued to launch new sustainable solutions for the transport sector as we started serial production of the 44-tonne heavy-duty range -- or up to 44-tonne heavy-duty range for Volvo, and we will come back to that. And that is a major milestone, of course.

So if you look to the volume development in the quarter, total truck deliveries increased with 21% to 53,300 units. That is also a record volume for the third quarter, which is both significant and astonishing, I have to say, given the uncertain times. But thanks to, and I'm almost getting emotional when I think about it, the relentless efforts in our sourcing and industrial system and with very, very close cooperation with all Truck business areas that is required. I cannot enough underline this team effort in very, very turbulent times.

The Volvo Construction Equipment deliveries decreased with 7%, mainly on the back of lower deliveries in China. But also here, we see really heavy lifting to execute volumes in other regions.

When it comes to the demand for electric vehicles and equipment, that continued to increase rapidly. And if we look to the 12-month rolling order intake, it passed actually 4,000 units. So it's starting to be somewhat material now. But I think the acceleration is really good here. For the quarter, electric orders across all business areas were above 1,200 units and delivery is about 500. So a strong momentum still and also good book-to-bill ratio.

Service sales -- service development, that is very close to my heart, as you know. We also had a strong service growth, 24%. And if we adjust for currency, plus 10%. That is showing the continuous high activity level, first and foremost, among our customers. But also that the efforts to increase contract penetration is continuing and is paying off. And that is, of course, important now when we are also building a strong population with the high deliveries.

So as we continue to work close with our customers to provide them with the best uptime and productivity, service sales 12-month rolling is now above SEK 100 billion, an impressive achievement by the organization. And the good news is that we still see lots of potential to continue on that journey.

When it comes to the Truck news, we have taken significant steps, as I said, on electrification during the quarter in September, week 37 to be precise. And as the first global and I should really say the first truck manufacturer, we started series production of heavy electric trucks with the trucks up to 44 tonnes gross combination weight. And that is covering the Volvo FH, the Volvo FM and the Volvo FMX models. And they were then added to our already broad range of medium- and also heavy-duty -- or semi-heavy duty trucks. So after this launch, Volvo Trucks electric portfolio could cover around 45% of all goods transported in Europe today.

But let's have a look how it looked into -- when we started production. We have a small film here with Sandra, who is the Head of Tuve operations.

[Presentation]

[Martin Lundstedt, executive]

Thank you, Sandra. I mean how cool is that? This is actually history unfolding in front of our eyes. In addition to that, I mean, we also got an important order from Amazon. We will supply, of this range now, 20 heavy-duty electric trucks to them in Germany. These vehicles have a range of up to 300 kilometers, but also with the route planning, together with them, it can cover up to 500 kilometers during a normal work day if a top-up charge is added in connection to a scheduled break or a scheduled loading/unloading situation. So those are the applications we will start to see here.

Also in October, just after the quarter closing, Renault also announced Renault Trucks opened up for preorder of its 44-tonne electric heavy-duty range and production of these vehicles is due to start at the end of next year in Bourg-en-Bresse, France.

In August, we initiated also the process to establish a plant for battery production in Sweden. We do this to meet this growing demand for battery electric heavy-duty vehicles and machines, as we just have discussed here. We will establish this large-scale production plant for battery cells in Sweden for high-performing batteries and battery cells along with partners, and we will use fossil-free energy. This is an investment that will take place gradually as demand will continue to grow and will complement volumes from other partner facilities.

When we look at the truck market forecast on the back of the high transport activities that we still continue to see and also pent-up replacement needs, the demand for trucks continue to be strong. The industry remains driven still by supply rather than demand. So we keep our 2022 market forecast unchanged both for Europe and North America, but it will ultimately also, for this year, depend on how much the industry as a whole can deliver.

As the first and early forecast for 2023, we guide for a similar level as 2022 of 300,000 units in both Europe and North America.

The market in Brazil is currently strong, especially driven by the agriculture segment and also prebuy ahead of Euro 6 regulation that will start in 2023. But we expect the market to soften somewhat into 2023 with a level of 80,000 units.

Demand for trucks in India after some weak years continues to grow. The forecast for this year is increased to 350,000 units and 400,000 units for next year.

And we reiterate the Chinese market for this year at 800,000 for medium- and heavy-duty and a moderate increase next year to 850,000 units.

But I also would like to be clear that the market forecasts are based on current visibility, which is still low and with significant uncertainty.

When we look at the truck orders, orders in quarter 3 increased with 27% as we gradually have opened the order books and we have seen strong momentum. You had already seen that for the American figures, obviously. But also, as you can see in our report also that goes for Europe and not at least the strong momentum for Volvo Trucks. Deliveries increased with 21% as I've already said, and it was a third quarter record both in production and delivery volumes as we continued then to push the boundaries to satisfy the need from customers. This has, of course, come along with extraordinary efforts and related costs, but it has been the right balance as we build population for the years to come and execute on the strong order book.

As regard market shares, we start with Europe, where we had a strong development, both for Volvo and Renault growing to 18.9% and 9.7%, respectively. So strong development. Also, the electric market share in Europe were strong with 30.9% for Volvo and almost 23% for Renault.

And in North America, Volvo is growing up to 10.3%, while Mack is down to just below 6%. For Mack, we are currently more hit than the other brands since we have specific problems with a number of specific suppliers for the Mack brand here.

In Brazil, we have a strong performance and growing the market share to 25%. And South Africa coming down somewhere just above 20%, but from high levels whereas Australia is coming back now with a combined market share for Volvo and Mack, again north of 20%.

So if we then move to Construction Equipment and some news here. The global rollout of electric -- sale of electric equipment continues. We are now also adding South Korea and China. And as you can see here, for example, with the ECR25 and EC55 electric excavators, but also along with an extensive offering of charging solutions.

And we do see a continued good momentum in construction equipment electric sales with order intake up 98% and deliveries up with 147%.

When it comes to the market forecast for Construction Equipment, the construction activity has remained on good levels in many regions. We have already talked about China, obviously, and the correction there, but in other regions primarily driven by the ongoing infrastructure investments, and in the longer term, there is a need to continue to renew and expand an aging infrastructure. However, recent interest rate increases have made customers in some markets more cautious about the near future.

The market forecast update is as follows. As you can see for North America and Europe, we guide for a similar pattern. We changed a little bit the '22 forecast. We lower by 5 percentage points. So now we guide for a plus 5% as midpoint. And we guide for a flat market after that, both for Europe and North America in relation to 2022.

South America, no change for this year, plus 10%. And a somewhat a decline for next year, minus 5% as midpoint.

And for China, to comment that also specifically, no change for this year, minus 35%, and a further decrease then with minus 10% as midpoint for next year. And also here, of course, market forecasts are based on current visibility that is low with significant uncertainties.

Order intake. Net order intake declined by 32%. Main reason for this has been restrictive order slotting into our order books due to the very large order books that we have. You can see that we normally take North America as an example. We need to execute on the bubble here. And from time to time I get the question, I mean, how can you manage that? I think the good news is it's first in, first out. So it's, of course, a moving. But when the order board are really long out in time, we need to be restrictive. But it's also somewhat more cautious customers in Europe that has impacted. The lower order intake is also an effect of the halted sales in Russia and high order intake in quarter 3 last year, so comparison figures. So order intake in Europe was 28% lower than last year when excluding Russia.

But when it comes to deliveries, it decreased by 7% with a negative impact from lower volumes in China and then partially mitigated by better deliveries in other markets. In Europe then, in particular, deliveries were 3% higher than the prior year when excluding Russia.

Volvo Buses, that have been struggling with a low demand and very uncertain outlook given all the restrictions about order intake, increased with 3%. And significant orders were received in Mexico, almost 400 units; Brazil, almost 200 units; and Australia, 130 units. Deliveries increased with 19%. And as you can see on this photo slide here, the new Volvo 9800 Euro 6 coach is well received in Mexico. We have received major orders that will be delivered next year. And we have actually 57% market share year-to-date in the coach segment in Mexico with good profitability.

On the Penta side, the order intake was on par with last year, high levels, high activity levels amongst our customers. Deliveries increased by 14%. But also for Penta, the quarter has continued to be a lot about prioritizing the realization of a strong order book with lots of extraordinary efforts and thereby also extra cost. A new range of variable speed generator sets for marine applications has also been launched during the quarter.

When it comes to Financial Services, of course, a very important indicator about the annual state of our industries and verticals. It was a strong quarter despite the increased competitive landscape. We had record new business volumes for the third quarter. New retail finance volumes up with 24% or 12% currency adjusted despite the loss of the Russian business and the slowdown in China.

We had stable finance penetration levels despite this intense competition with decreased spreads. And we also had a very good portfolio performance. It remained stable in most parts of the world due to the good customer activity levels, both for transportation and construction work.

So that concludes the business update, and I will hand over to Tina for the financial updates.

[Tina Hultkvist, executive]

Thank you very much, Martin. And also from my side then, nice to see everyone again. Good to be here. Let's move in to -- let's look at the sales for the group. We have a sales in the quarter of SEK 115 billion, which is an increase of SEK 17 billion if we exclude currency impacts. We have good volume growth in the quarter, but we also have good support from good service sales, both in Trucks and in the Bus business. And then on top of that, we also have good improvements in the price realization, which impacts the sales.

All regions are contributing, but we have the main impact in North America, where the deliveries from Trucks and VCE is increasing significantly from last year due to the high business activities in Americas. On top of that, we have good support also from the currency impacts and the main part of that is, of course, driven by the development we have on the dollar.

Moving into the group performance. We have an operating income of SEK 11.9 billion in the quarter and a margin of 10.3%. Despite the supply chain disturbances that has continued throughout the quarter, we managed to get really high volumes out from the system and our plants. The good Service sales that Martin and myself also talked about is also contributing to the financial performance.

We have worked actively to increase the prices in the quarter, and we have managed to offset the extra costs that we have from inflation. We are continuing to invest in the current platform and in the coming platforms on the product side. The net impact from capitalized and amortized R&D, you can see on the slide here, it's positive in the quarter. We expect this to be roughly on the same level for next quarter. That means that on a full year level, we will have an impact -- net impact from capitalized and amortized R&D of roughly SEK 2 billion for the full year.

We have a bit of an increase on the operating expenses. A part of that, roughly half, is coming from currency impacts. Currencies is supporting the performance in the quarter of some SEK 2.4 billion. We guide usually on currency impacts and the transactional impact, and our guidance right now is that this will land on a level of roughly SEK 5 billion for the full year.

Moving into cash flow. We have a strong cash flow in the quarter of almost SEK 15 billion. Cash flow is mainly driven by the result, but we have also, despite the supply chain disturbances, managed to release almost SEK 6 billion from working capital. Part of that is coming from the inventories and inventories remains to be a very important area for us to focus on, especially considering the market outlook that we have for the coming year.

We keep strengthening the financial position, and we leave the quarter with a net cash of almost SEK 60 billion.

Moving into Trucks. Good volumes in Trucks in the quarter, best Q3 ever in terms of deliveries despite the supply disturbances that we've had. Sales is also supported by the good service growth and the increased prices that we have made in the quarter. Supply disturbances has continued in the quarter and that has also impacted the industrial system where we are not running with full efficiencies as of now.

With the rising energy prices that we've seen, especially from -- after summer holidays, we have seen an increasing need to support our suppliers financially. This has gradually been growing throughout the third quarter and we expect that to continue also in the coming quarters. At the same time, the commercial organization has done really strong efforts to increase prices, and we have been able to offset the extra cost for inflation in the quarter.

Investments in R&D is continuing in Trucks in order to stay ahead of competition, and we also see a bit of increases on operating expenses partly connected to the increased business activities and the volumes and partly connected to the currency impacts.

The truck market in China was strong last year. This year, the truck market is down by roughly 2/3. That has had an impact on our joint venture in China, DFCV.

But all in all, we have a margin of 9.7% for Trucks in the quarter.

Moving into Construction Equipment. Also VCE is impacted by the market drop in China. The construction market is down by roughly half of what it was last year. On the other hand, the North America business for Construction Equipment is growing. We have worked intensively with price realization for VCE, and we have been able to offset the extra cost for inflation also in Construction Equipment in the quarter. And VCE ends the quarter with a margin of 15.6%, supported by currencies.

Moving into Buses. Good sales growth in Buses in the quarter. Sales is driven by more electric buses and also more complete buses from Mexico. We also see a good service growth in Buses, particularly in Americas, which is driven by the higher utilization of the fleet that we have there. This is a pattern that we have seen for the last quarters, and that is continuing.

In Buses, though, we have long lead times from the day when we take a contract with a customer until we actually produce and deliver the buses. That has meant that we have not been able to offset the extra costs for inflation for Buses in this quarter. So despite the higher sales, Buses is leaving the quarter with a margin of 2% supported by currencies.

Moving into Volvo Penta. Volvo Penta has a strong demand from the customers, both on the engine side and on services. And we have good volume growth, sales that is up by 20%, excluding currencies. Price increases are coming through, and we are in Penta able to offset the extra cost for inflation in the quarter.

All in all, though, the supply chain disturbances, the investments that we do in transformation in Penta and a bit of increase in the operating expenses has impacted the financial performance. So Volvo Penta leaves the quarter with a margin of 13.3% supported by currencies.

Moving into Financial Services. The customer financing operation is -- continued to do well, and we continued to grow the credit portfolio. Our customers and our customer's customers are continuing to do well. We have a healthy portfolio in VFS with low delinquencies and low write-offs in the quarter.

On the other hand, we start to see a margin compression connected to the higher funding rates and this has not been possible to offset in the market due to the high competition from the banks. This, together with some higher operating expenses in VFS, has impacted the profitability. All in all, though, we still have a good profitability in the customer financing operation with a return on equity a bit above 16% for the last year.

By that, I think I stop the financial part of the presentation and welcome Martin back onstage.

[Martin Lundstedt, executive]

Thank you, Tina. So we do finally a short summary then of the quarter. I think this has been a quarter with a lot of moving parameters. So that's the reason also why we'll spend a little bit more time on that, what has happened both when it comes to the priorities and the results of quarter 3.

First and foremost, it starts with our customers out there and their activity levels that continue to be high, which is then translated into a strong demand for machines, trucks and services. And therefore, our clear main priority is to continue to materialize the strong order board that we have, to satisfy, of course, the customer needs, but also for us then to build an even stronger population in the rolling fleet for the future that will serve us well also in the coming years here. And the outcome in financial and operating performance is third quarter records for sales and operating income for the group, as well as record production delivery -- production and delivery volumes with increased market shares for Trucks.

The flip side when you make that priority is a somewhat weaker margin, especially then on the Trucks side somewhat weaker margin, but with strong operating cash flow and return on capital employed exceeding 27% and also an increase of the earnings per share with 22%. And this is also confirmed by the continuous strong order intake that is actually confirming the activity level among our customers.

We also continue to lead the transformation, as you have seen, both in the field and what we have talked about with the start of serial production of heavy-duty trucks in Sweden.

So all in all, I'm very proud of what all employees, all colleagues, all business partners have done and how actually we have achieved the right balance in a very turbulent quarter.

So by that, Claes, I think we conclude the presentation and then we open up for questions, right?

[Claes Eliasson, executive]

Thank you very much, Martin, and you're absolutely correct. That is what we are planning to do now. So in an ordinary manner, we will let you ask your questions. And if you could limit them to 2, we will be very grateful. And we actually have our first questioner. Hampus, go ahead.

[Hampus Engellau, analyst]

Hampus Engellau, Handelsbanken. Two questions then. I'll go on the FX, SEK 5 billion contribution guidance for the full year. Third quarter, 30% of Volvo Construction EBIT was FX. Should we expect a similar mix going into Q4?

Second question is more on the order intake in North America. We had market being down 4% with fully booming September and you were down 14%. Is this just an effect of being maybe late in totally opening up the order book while the others were a bit ahead of you guys? Those are my 2 questions.

[Tina Hultkvist, executive]

Yes. I think on the currencies, I think we give you the guidance that we have there. And as long as the mix is continuing, I mean, for VCE, it's also a consequence of the fact that we are growing in North America. So that is impacting. So I think that we should not talk about, of course, what the result will be, but I think that the trend is in sort of in that direction, yes.

[Martin Lundstedt, executive]

And then when it comes to the order intake, I think when we look at the different brands in North America, obviously, we -- I mean if we start with Mack, we have a very long order book still and that you can see also when you look at the curves actually and we are continuing to manage that carefully also. And the same goes actually for Volvo Trucks in North America.

So it's not a problem with the length and the quality of the order board. It's more about, I think, what is the different strategies for different brands given that continuous high demand that is out there. And also what you have seen when we have now gradually opened up, I mean, the customers are there to book. So it's still about managing the lead times and -- because both for the uncertainty that we still have in the supply chain and we have really stretched, as you have seen also with the market share development, but also given the uncertainty about the cost development. So we have a serious discussion with our customers. I mean all our customers have faces, we know them. We need to live with what we are concluding for a long time together. So that is the balance.

[Claes Eliasson, executive]

Thank you very much, guys. So let's take Björn from Danske.

[Björn Enarson, analyst]

Yes, first question on the battery plants investments. A lot of uncertainty on how much you will spend there. Can you say something on the headwinds on -- dividend headwinds -- dividend capacity headwinds from those investments?

And second question also on batteries. If you can say something on the returns on those investments. I mean is this sunk CapEx or should we expect lowered returns on capital? Or how should we think there?

[Martin Lundstedt, executive]

First and foremost, when it comes to the expansion then of cell capacity, I think it's important to remember that regardless if you do it yourself or with partners, you have to pay it because there will be dedicated lines. So either you take it on operating expenses or you take it as CapEx or a mix between the 2. We have preferred to take it as a mix between the 2. We think that is wise because then we will also secure the capacity since we also have a leading position when it comes to electrification.

This will be gradual over many years. And knowing the size of the group, et cetera, and knowing also the approximate investments that has been announced in other similar projects, I think it's not that difficult to do the calculation of how big the risk it will be of significant headwind that I cannot see from my perspective because we are still standing still -- or standing firm with our financial targets and also what we talked about in the -- during the Capital Markets Day, meaning that financial targets, but with significant growth opportunities. That is, so to speak, the story moving forward. And that is, I think, also responding to the second question.

[Claes Eliasson, executive]

Excellent. Shall we see if we have someone on the phone as well. Operator, do we have someone there?

[Operator]

[Operator Instructions] The first telephone question today is from Nancy Ni from Goldman Sachs.

[Daniela Costa, analyst]

It's actually Daniela here. I'll ask 2 as well. The first one, I just wanted to understand on the margin development on Trucks, on the year-on-year margin development. I understand sort of some of your comments on headwinds, but it looks like looking at deliveries and sales that you're doing better on the pricing. We're hearing a lot about easing on supply chain, raw material costs falling. The key point that seems new is the commentary about supporting your suppliers. Can you give us a little bit more detail on that? And is that the main cause of the year-on-year drop, if you could help us there?

And then the second point that I wanted to ask was regarding -- it's a follow-up actually on the prior question on dividends and cash. I think in the past, you very helpfully had guided us to I think it was around an operational cash need of about SEK 30 billion staying in the company. You were very cash generative this quarter. You normally are very cash generative in Q4 as well. Does the environment change in any ways? How do you think about that cash that you need to keep versus what you see as excess cash to potentially distribute to shareholders?

[Martin Lundstedt, executive]

I don't know, Tina, if you would like to start.

[Tina Hultkvist, executive]

Yes. Maybe I should start with the margin on Trucks and what is the impact there. What I mentioned there on the support of the suppliers, that's something that we've seen gradually throughout the third quarter and that is, of course, a part of the extra cost that we are having. That will continue going forward.

But we also have extra costs in production connected to what Martin was talking about regarding that. The extra marginal trucks that we are doing are quite expensive, but we have found that to be the right balance in order to support our customers, to stay in the relationship with the customers and also to build the fleet out there and really to earn the money on the service business going forward. So there is a balance to strike and this is what we have chosen to do. And we think that is the right way in order to keep the relationship with the customers.

[Martin Lundstedt, executive]

And all of you know, of course, I mean, if you look at the P&L of a truck, of a single truck over the life cycle, even if the marginal -- I mean, the last 5%, 6% of trucks now are coming with a, so to speak, low gross margin theoretically. It's a really good deal also for us, but more importantly also, it's a really good deal for the customers. So I mean not doing that priority when we actually can stretch the system is not the right decision to take in a situation like that, to Tina's point.

Maybe just to add, of course, we have a mix effect also. When you look at, I mean, the product mix on Trucks and when you look at the mix between hardware and services, because even if we have been growing services really well during the quarter, you don't do it with the same magnitude if you can accelerate hardware as we have been able to do now. So there are a number of parameters.

I think the main message is that the gross income margin still has high quality, well understood, well managed and it's all about how you put the priorities. And the priorities has been on the absolute level of volume serving customers, on the absolute level on operating income because that is the value creation and the cash flow. So a very decisive prioritization.

Then when it comes to our financial position, obviously, I mean, as always, this is a discussion that first will take place in the Board and then eventually being contemplated as a proposal to our shareholders. I think it has been clear to everyone that the group is clear about the fact that a strong financial position, good financial maneuverability is needed in order to lead the transformation. But we are also being clear on that we should be an attractive case to our investors. And if we look back, I think we have been very consistent in that story.

At this moment in time, I think everyone is really grateful also that you have industrial companies with a strong financial position. I think that is serving everyone well, not at least the shareholders.

[Claes Eliasson, executive]

Good. Yes, are we good there? So let's take one in the room, or 2.

[Agnieszka Vilela, analyst]

Perfect. Agnieszka Vilela at Nordea. So we've learned with this report that you have this kind of new pressures when it comes to the cost side, you're supporting your suppliers. I just wonder, given the fact that you have taken so many orders in the quarter, did you take that cost situation into account when you set the prices? And do you believe that you can kind of balance it off when you deliver these trucks?

[Tina Hultkvist, executive]

Well, we always think about the cost side when we work with the prices. We have been quite successful raising prices and increasing prices in the last quarters, so is the case also for Q3. We will continue working actively with that, of course, and it's always a balancing act between what we see on the cost side and what we need to do in order to offset that. But what we have done historically we will continue doing, of course, to do our utmost to offset what we see.

[Agnieszka Vilela, analyst]

And maybe a follow-up on that. Do you see any kind of cost headwinds easing already when it comes to commodity prices or freight cost?

[Tina Hultkvist, executive]

There is a bit of a lead time also in the commodity prices and how they are moving, so that's one part of it. But the commodity prices are a little bit going down. But on the other hand, we see the other cost increases that we mentioned from the suppliers, which is increasing. So how that balance out all in all, I mean, the net impact of that is very difficult to try to foresee and how the timing of that is coming in. I think that we should not -- it's very difficult to forecast exactly how that comes in. But we see both those trends coming on.

[Martin Lundstedt, executive]

But I think also just to add to what Tina said, I think we have a very robust methodology then it can always be a little bit about time phasing. We have seen that during -- not only during, between different quarters, but also between different months actually because it has been so quick development, both up and down, but mainly up now lately. But of course, we will start to see effect when we look at both logistics and raw material. But to Tina's point, following, but a robust methodology how we work with our price realization together with the cost increases.

[Claes Eliasson, executive]

All right. Thank you. Operator, do we have any more questions from the telephone line?

[Operator]

Yes, we have quite a few. The next question is from the line of Mattias Holmberg from DNB Markets.

[Mattias Holmberg, analyst]

I have 2 questions, I'll take them at once. Last year, we saw quite large truck order cancellations in the North American market. I understand that was due to oversubscriptions more in the context for your peers rather than the Volvo Group. And when I look at production schedules, once again it seems like it's quite big oversubscriptions for Q4 in North America. So my question is do you see any risks of cancellations to orders or orders being pushed into 2023? Or would this rather be a risk for other players in the industry?

My second question was relating to the battery factory in Sweden. I would wonder if you could elaborate a bit on what geographic coverage you expect from this one, and what your plan is on the battery supply for geographies that are out of scope to be covered by the factory in Sweden, please.

[Martin Lundstedt, executive]

Yes. I mean if we start with North America, if I understood it correctly, I mean, if we see any risk for cancellation and the quality of our order board and the activity level and so on. And I was actually over -- we were actually over a couple of ones last week and a very strong activity level. We had also, of course, business reviews and we feel that what we have in the order board and also what we see in order intake is very robust actually. And that is also, of course, we have a rather sizable, as you know, used truck retail arm also with Arrow. So we have a good view of what is happening there. And we have seen some sort of decline natural because it has been extremely high pricing on the used side, as you know.

But generally speaking, we feel it's a robust situation, well-managed. If anything, that's also, as you did see on the Mack truck order intake, a little bit hampered by the fact that we cannot just continue to push out the order board in time.

On the cell manufacturing in Mariestad in Skaraborg, it will be primarily for Europe. And we will, of course, have also regional footprints for other geographies. And that will continue. And as you have seen, we have already announced a number of partnerships where we are combining our own capacities also with partnership capacities, and that will be the strategy moving forward as well.

For several reasons, it will be regional value chains, as you know. There are a number of both regulations and trade optimizations around that. But also for us, it's about logistic optimization. And it's about also really building green value chains for that specific part. So it's primarily for Europe, but also, of course, for European production meaning serving other markets as well.

[Mattias Holmberg, analyst]

Just if I could clarify the first question. If you see any risks for oversubscriptions in the build slots.

[Martin Lundstedt, executive]

Ah, so you mean hedging basically. Speculations order.

[Mattias Holmberg, analyst]

Yes.

[Martin Lundstedt, executive]

No, because if we look at also our dealer pipelines, et cetera, are on -- still on extremely low levels. So no for the time being.

[Operator]

Next telephone question is from the line of Klas Bergelind from Citi.

[Klas Bergelind, analyst]

Klas at Citi. I just want to start first on the Truck margin, but looking beyond the current cost inflation as most of this is temporary and assuming on the likely drop-through when volumes eventually come down, you have a lot of inefficiencies that will reverse under a weaker demand backdrop. To me, it looks like the first 10% down on volume we'll see a pretty stable margin as these headwinds reverse. It would be great to get your thoughts there, Martin. Lots of headwinds, but this under absorption effect can become a pretty big tailwind when things are easing.

[Martin Lundstedt, executive]

Thank you, Klas. No, I think you are absolutely right. Obviously, when you all -- as we said, first and foremost, you have a natural mix effect between products and services. And since you're always optimizing for volumes in the 2 main streams there, that will in itself have, so to speak, an opportunity into it, if I put it like that.

The second piece is, obviously, as you say, that is clear and that's the reason why we are clear about it, if we should have gone for margin optimization, we should not have produced to the level that we did. Then we should have produced x percent less if that should have been the endgame. It was not the endgame for us, the endgame was to push the boundaries when it comes to production and delivery volumes because that is the right decision to take now to materialize the order board. And we took a deliberate stance that, that will have a dilution temporarily for the margin. And in our book, that is the right balance for the customers, for the shareholders and for the employees.

[Klas Bergelind, analyst]

Yes, makes sense. My second one is a follow-up to the question before on upcoming investments. A lot of things going on, we have cell manufacturing, assembly of battery packs, we have the China manufacturing, we have infrastructure charging, we have ongoing investments into cellcentric and so forth and our R&D is trending higher. I don't think it will give us an all-in investment number, Martin, but maybe you can comment on the timing. When will cell manufacturing kick off? And then, in particular, zooming in on your China localization effort, whether that will start consuming CapEx already in 2023.

[Martin Lundstedt, executive]

Yes. I mean, first and foremost, I think partly and very important -- part of your question was very important and that's exactly to mention how we are actually working with these different initiatives. It's a lot about partnership, right? And that is to actually drive the agenda, but at the same time also make sure that we are sharing these efforts, both from a pure CapEx, but more also from a resource allocation but also from a speed execution actually because, I mean, what we are now doing is that we're moving from a brown fossil-based platform up to green one. And that, in certain aspects, need also a coordinated effort. So I think we have found a very good way of actually working with this mosaic of different initiatives.

Having said that, on the cell manufacturing, that will be, as we have said, a step-wise investment over a decade or so, meaning that if you look at the total numbers, that will not be -- of course, it will be material because it's a big bet and a necessary bet as we have done on ICE powertrain components, both internally and externally, where we in all main components have dedicated lines, so that is similar.

But also when it comes to the China footprint, we are continuing. All the different prerequisites are not fully in place, so we will see when and how that will actually be executed.

I think the main story, as we have said, is that we have reiterated our financial targets and we have said that this transformation is giving a growth opportunity that will be accelerated to the -- in relation to the historical growth -- or higher growth than we have said historically. That is including actually how we think about CapEx and how we think about R&D. So we feel that we have a great story to execute upon.

[Klas Bergelind, analyst]

Yes. No, it's in line with our view that this is going to be spread over time, so that's good. I was just thinking whether any of these categories will be a little bit more front end-loaded. And given that China is now coming back and it's such a great opportunity on premium heavy-duty, whether that will be more front end-loaded over the investment horizon. That was really my question.

[Martin Lundstedt, executive]

Yes. No, no, but again, I mean, we are not disclosing the exact numbers on that. But I think even if there are -- those are big investment. As we said, they should be manageable in what we have said about our financial targets and our growth ambitions.

[Operator]

Next telephone question is from the line of Tom Narayan from RBC.

[Gautam Narayan, analyst]

It's Tom Narayan, RBC. My first one is on the 2023 market outlook for Trucks. Just curious if you could comment on age of fleet, if you had any metrics there. And this seems -- the biggest driver seems to be the pent-up demand, obviously. Just curious how you put together that guidance and what kind of recession are you baking in for Europe, for example?

And then my second question, and I know we've already gone over this quite a bit, on the cost issues on Trucks. There were the 4 of them. I understand material, R&D, freight. The selling expense, I just want to understand, is this just related to the higher orders, and in which case, it's kind of a good thing? Just trying to understand the sustainability of some of these cost items.

[Martin Lundstedt, executive]

Yes, let's see, the age fleet, yes. Yes, as we see it, I mean, now it has been a couple of years actually with where supply has decided the market and not demand. And so when we -- and I will not go through in detail how we assemble the different data for different markets actually, but I think that we have a pretty robust way of doing this. Remembering it's still early out -- early guidance for 2023. We acknowledge exactly what you said, Tom, high uncertainty, how will it look like when it comes to the general economy, et cetera.

But given the fact that we have had this supply-constrained market for some years, when we look at the age or the aging of the fleet, when we talk to the customers, when we look at our connected data, et cetera, that is supporting a rather big part of this. So the majority of -- I mean, the volume buildup not at Eastern Europe is based on replacement and not when it comes to expansion. And we see that when it comes to fuel consumption, when it comes to repair and maintenance costs, et cetera, that is important and a big deal for the customers to get these trucks out.

So yes, that is basically how we think about it for the different regions and how we build it up. And that is both the bottom-up analysis and a top-down and a lot of different type of triangulation, I can tell. But this is the forecast.

[Tina Hultkvist, executive]

Yes. And then coming back to the cost side on -- in group Trucks and the selling expenses, of course, a part of the increase that we see is connected to the higher business activities that are ongoing. It's quite substantially higher than if we compare to where we were last year. And then, of course, the selling expenses and the commercial areas, they are spread in all regions and markets in the world. And that, of course, has a quite substantial exposure to currency impacts. So that's the second part in the selling expenses. So business activities and currencies are the drivers behind.

[Operator]

Next telephone question is from Michael Jacks, Bank of America.

[Michael Jacks, analyst]

I have a question on cost as well, I know we've covered this extensively already. But I guess my question is more that the gross margin deterioration, it's much smaller than the deterioration that we've seen at an operating margin level and this seems to be most visible in the Construction Equipment, where if you were to strip out the ForEx tailwind, the margin seems to have deteriorated much more. Just if you could possibly give us a sense in terms of why the selling costs or R&D impact would have a higher impact relatively speaking in the Construction Equipment division? I'll start there.

[Tina Hultkvist, executive]

I can start and then you can add on, Martin. I think also in VCE, of course the currency impact is a main part of the explanation, big operation in other countries, of course, outside of Sweden. That has a big impact on selling expenses. Also the general activity levels.

Then we are also investing quite a lot in product platforms and transform activities, electric vehicles and so on in the Construction Equipment and that is somewhat increasing. So that's a big part also on the drop between gross income and the operating margin.

[Martin Lundstedt, executive]

No, I think it's great outline.

[Claes Eliasson, executive]

Did you have a second question as well?

[Michael Jacks, analyst]

Yes. Maybe just a follow-up on that one quickly. So just in terms of the overall level of the OpEx and R&D spend in Construction Equipment, should we expect that to continue for the coming quarters?

[Tina Hultkvist, executive]

I think, currencies, we should not say so much about what will happen with that going forward. We will be there, of course, with whatever currency impact we will have. But the investments will continue, of course. We are keeping investing in the Construction Equipment. So on the R&D side, yes. We will keep investing in new products also in that portfolio.

[Martin Lundstedt, executive]

And just to add to what Tina says from a business perspective, I think we have done -- and the Volvo Construction Equipment team had done a fantastic job to really lift that company in all different aspects, I mean, even with a currency tailwind now of 15.6% in the quarter. And of course, we should invest in R&D. Of course, we should invest in innovation when we have this platform. Of course, we should do that for the future. So yes, absolutely that would be great.

[Michael Jacks, analyst]

Understood. Then maybe one final question just on Construction Equipment. Are you seeing any signs of improvement in customer activity levels in China yet?

[Martin Lundstedt, executive]

Can I take it? No. I mean, of course, there is a certain activity, otherwise, the market should have dropped even more. But I think it's early out to say. As you know, also the Congress is ongoing now and let's see what will happen after that. I think, again, the organization has done a good job to make the necessary adoptions. We are following it very closely.

But as we also said in our guidance, I mean, flattish market we are guiding with the current knowledge then for Trucks and a further decrease as we see it, less so than for next year in relation to this year. But that is our current expectation, then we know that there can be changes depending also on how the cooperation between the state and the corporate sector is working in China.

[Michael Jacks, analyst]

And then maybe just bringing this together, sorry, one final add-on question, if I may. Maybe just in terms of you mentioned in the report you've seen a mild slowdown impacts in Construction Equipment in Europe. In the event that, that mild slowdown becomes a more severe slowdown, how quickly could you cut back on those costs that we mentioned in my second question? And that will be my final question.

[Martin Lundstedt, executive]

No. But both for Construction Equipment for the other business areas, of course, a key priority for us is to continue to have a high flexibility in all different cost disciplines because we are humble. We know that cyclicality is strong from time to time and we need to have that high flexibility. So we have a contingency for that.

[Operator]

Next question is from the line of Miguel Borrega from BNP Paribas Exane.

[Miguel Nabeiro Ensinas Serra Borrega, analyst]

I have 2, the first one is just on the Truck margin. I just wanted to understand the volatility in Q3 relative to the first half. Was there anything abnormally high in the first half, perhaps pension release from higher interest rates? Because actually Services weighted more as a percentage of revenues than engines in Q3 relative to Q2.

And then I know that you don't give any guidance for margins, but where do you see this normalizing? Are we talking about the 10%? Is this the level you see more normal? Or do you aspire to maintain the 12%?

[Martin Lundstedt, executive]

Would you like to start?

[Tina Hultkvist, executive]

Yes. Sorry, I can start. I mean what has been new since what we saw in the beginning of the year is, of course, the extra cost to support our suppliers. I think that's one thing to stress further. Also the extra cost in production connected to what we call then the marginal trucks, that has also been sort of increasing as we have been moving along throughout the quarter or throughout the year. So I think that's 2 main explanations. And maybe you want to add something also, Martin.

[Martin Lundstedt, executive]

And obviously, I mean, when you say volatility, it depends on how you look upon it. But I mean we have a vacation quarter also that is always, I mean, a little bit back and forth that you need to take into account. As I said, and I think that might be one of the key messages, when we look at the constitution of the gross margin, I feel that we have, so to speak, a good balance in that given the decisions that we have been taking. So we don't see a part then from a very extraordinary situation now with the cost pressure coming from energy prices, et cetera, for our suppliers. And we have been able to push that through in a positive way and then that we have taken a decision to further stretch the system. I mean to get out 50-plus thousand units in the quarter 3 here does not come without really hard efforts and also deliberate decision with extra cost. So that is how I see it. I mean so you should not overstate the volatility in my book.

[Claes Eliasson, executive]

Okay. I think that concludes this meeting. So thank you very much. And January 26 next time, right?

[Martin Lundstedt, executive]

Absolutely.

[Claes Eliasson, executive]

So I hope to see you again by then. So over and out. Thank you very much.

[Martin Lundstedt, executive]

Thank you very much. Take care.

[Tina Hultkvist, executive]

Thank you.