Vitesco Technologies Group AG

XETRA:VTSC

Earnings Call Transcript 2022-Q3

[Heiko Eber, executive]

Andreas Wolf, our CEO; and Werner Volz, our CFO; and [indiscernible] guide you through our presentation of the financial results. As always, they will report on the most important developments of the last quarter, the group and business unit development as well as our cash flow and balance sheet. Finally, we will discuss our updated financial outlook for fiscal year 2022. And afterwards, both gentlemen will be available for a Q&A opportunity as usual.

And now without further ado, let me hand over to our CEO, Andreas Wolf.

[Andreas Wolf, executive]

Yes. Thank you, Heiko, and thank you very much, ladies and gentlemen, for joining today. The third quarter is in the books. Finally, we have seen a pickup in the worldwide light vehicle production again. And we could also benefit from the slightly improved availability of semiconductors.

As a result, EUR 2.3 billion of sales in the single quarter and an adjusted EBIT margin of 2.1%. We are moving into the right direction.

Even though our third quarter was slightly negative in terms of cash flow, it was another solid quarter overall. Hence, very important, our electrification momentum continues. With EUR 230 million of total electrification sales in quarter 3, we are absolutely on track of achieving the target as EUR 1 billion for the full year.

Once more, our order intake proves our ID attractive product portfolio, EUR 4.3 billion order intake in total, thereof awards worth EUR 3.2 billion in electrification. That means we have achieved electrification order intake of almost EUR 10 billion in the first 9 months of 2022. I repeat, we have achieved an electrification order intake of almost EUR 10 billion in the first 9 months of 2022.

By the way, the EUR 3.2 billion in Q3 include the EUR 1 billion thermal management system order, which we announced during our Capital Market Day in October. And they also include an award of around EUR 300 million, which we received by a global German OEM for our battery management solutions. That means the total of EUR 3 billion year-to-date for battery management alone.

You see, we are winning business in all major regions and across our entire electrification portfolio.

Let us now take a closer look at the financial KPIs. The EUR 2.3 billion sales, which I mentioned correspond to more than 20% increase compared to the third quarter of 2021. Of course, FX was a significant contributor. This also results in an increase of our profitability by 0.8 percentage points. However, the high input costs are still a significant burden. And therefore, the operating leverage is rather low.

Considering the uncertainties in the market, we also limited our CapEx in the third quarter. Nevertheless, our free cash flow came in negative. This was mainly due to working capital seasonality combined with additional inventory buildup.

Back to sales. If you analyze our sales development compared to the market, which grew by 27.5%, our organic sales development looks rather weak at the first pledge. However, you have to consider the significant up and down in vehicle production in quarter 3 and quarter 4, 2021, which led to a negative and positive base effects combined with our respective outperformance and underperformance in those quarters.

More concrete, the higher sales base of last year's Q3 leads to lower organic sales rates for both the group and the core technologies, as you can see on the chart. However, that also means that we will outperform in quarter 4 again.

To sum it up, a difficult third quarter when it comes to outperformance but the continued strong performance of Vitesco Technologies when we look at the complete second half of 2022. And as always, you will now receive more insights into our financial development by Werner Volz.

[Werner Volz, executive]

Thank you, Andreas. Hello, and welcome also from my side. Ladies and gentlemen, as it was mentioned already, we almost doubled our profitability in Q3 compared to the prior year. We did that despite the continuous cost increases, especially in material, energy and freight. In Q3 alone, these topics led to gross headwinds of roughly EUR 180 million. Especially the material costs showed a sequential increase of the gross headwinds compared to Q2.

However, despite that, we are making good progress, passing on these additional costs to our customers, especially our core technologies improved in Q3. Almost EUR 300 million of sales increase and an adjusted EBIT margin of 4.5% in the single quarter compared to just 0.8% in the previous year. And this, of course, includes electrification technology, which in line with our plan continues to be loss making.

Let's assume now closer into electrification technology. You can see that the top line continues to be affected by the global semiconductor shortage. In addition, we were extending our production lines in our Chinese ET plant in Q3. This resulted in a lower production output for a time span of roughly 2 weeks and respectively, lower sales. As a result, we organically only grew by 16% to EUR 147 million. The sales increase -- this sales increase was mainly driven from the development in Germany and North America, which is, by the way, true for all our business units.

As a result of the limited sales increase, also profitability increased only slightly. We are now at minus 48.2% of sales, up 5.5% compared to the prior year. Once more, the real positive news is our electrification order intake. The business unit Electrification Technology alone recorded EUR 1.9 billion of orders in Q3. As a group we managed to win 3.2 billion lifetime electrification sales between July and September.

Now shifting to Electronic Controls. Here, we can see a real positive momentum. Electronic Control had the strongest organic growth among our 4 business units, reaching more than EUR 1 billion in Q3 2022. This top line recovery was mainly attributable to a slowly improving availability in semiconductors as well as pricing effects from the negotiations with our customers.

But while the overall availability of semiconductors is improving, partially missing customer-specific electronics continue to challenge our operations. And this challenge can also be seen in our adjusted EBIT margin. Yes, it improved year-on-year, but still is only at 4.3%.

The main driver for this improvement were our core technologies EC, which benefited most from the slightly improving environment. We increased our sales by more than EUR 200 million to EUR 704 million with an adjusted EBIT margin of 8.1%.

Now Sensing & Actuation, on the other hand, only grew by 11% to EUR 880 million. This is mainly due to the base effects in the prior year, which Andreas has explained already. Also here, we saw the main increase coming from the German and North American markets. The profitability in Sensing & Actuation was once more very strong at 8.9%, especially the core technologies contributed with 12.8% adjusted EBIT margin at EUR 683 million of sales.

In Contract Manufacturing, we also saw the effects of increased prices and currency tailwinds. As a result, we reported EUR 262 million of sales. Nevertheless, we continued with our phase-out, as you can see in the lower volumes for that business. The adjusted EBIT of 0.7% is already reflecting the bilateral productivities, which we have now mentioned already a couple of times in our last calls. All in all, we remain well on track with the phase-out of Contract Manufacturing.

Now let me give you some more insight into our cash development. As you already have seen across our industry, our cash flow is significantly impacted by continuous working capital buildup. The increase in accounts receivable is mainly related to the strong sales which we enjoyed in September. Also, we continued to build up inventory. And yes, this is a necessary measure in the short term to ensure production for our customers. But of course, we are not aiming to remain at these high inventory levels in the long term.

Besides our increased profitability, especially tax reimbursements in Mexico partially compensated for higher input costs and the increased working capital intensity. As a result, our operating cash flow was at EUR 81 million. Despite our cautious spending behavior, here, CapEx was more than 2 percentage points below the prior year. We saw a slightly negative free cash flow in Q3 overall. Again, mainly due to working capital. The figures of Q3 of 2021 are still highly influenced from spin-off effects and therefore not really comparable.

On the next slide, here, we see as a result of the negative cash flow and the currency changes. Our available cash slightly reduced to EUR 783 million at the end of Q3. Nevertheless, we continue to be in a very comfortable liquidity situation. At recent highlights, I can tell you that we managed to refinance our existing syndicated loan and replace it with a new one, as of October 6, with a tenor of 5 years with options to further extend. Our solid track record as a stand-alone company in the last year has certainly helped us here. And besides the new tenor, we also managed to achieve significantly more favorable conditions in our new RCF despite very volatile credit and financing markets worldwide. With the overall available amount remains unchanged at EUR 800 million, we negotiated significant improvements and ESG-linked credit conditions.

And at the same time, we also reduced our financial covenants to just one, the leverage ratio, which we comfortably be able to achieve.

If we now move to Slide 14, you can see once more the increased working capital levels in Q3 2022. Compared to the previous year, we have built up almost EUR 100 million in net working capital, which came besides negative currency effects mainly as mentioned a couple of times from inventories and the seasonal increase in accounts receivable. But I think, again, I have more than enough collaborated on these drivers already.

The other balance sheet related to KPIs continue to be very solid. The net debt ratio of minus 0.4% and net liquidity of more than EUR 300 million and an equity ratio of 40.7% underline our healthy balance sheet structure.

Finally, let us come to our guidance. Since the year is coming to close the view for year-end, it's clearer, more and more even though uncertainties in the market are still as high as they can possibly be. And event of a potential recession ahead in 2023 are still very, very hard to quantify.

But back to 2022. As a result of a better-than-expected worldwide light vehicle production, we feel now comfortable, we lift our sales guidance for the group to now EUR 9 billion to EUR 9.2 billion. Of course, our achievements in forwarding additional costs to our customers and FX tailwinds are supporting these figures as well.

However, we're not able to pass on all our input costs so that the smaller part still impacts our profitability. And the inflated sales from currency to only have a very limited drop through on our profitability. As a result, we will not reach the top end of our guidance, what the consensus, which is at 2.3% is already reflected.

We are now guiding for an adjusted EBIT margin of 2.3% to 2.5%. And also, this requires a rather profitable fourth quarter and further catch up for price increases with our customers since we are still below that range year-to-date. On special effects, the difference between adjusted EBIT and EBIT, we see them coming in lower than expected. We now achieve EUR 50 million to EUR 100 million as a realistic figure. We have already mentioned today that we are cautious on CapEx in these uncertain markets. As a result, we also lowered our CapEx forecast for this year to around 5%.

The clear focus remains on electrification. Therefore, this lower CapEx will not limit our growth opportunities in the future. This is, of course -- This, of course, affects our free cash flow positively on one side. However, we see strong headwinds from working capital on the other side. Overall, we do not expect more than EUR 75 million to be a more realistic figure for the fiscal year 2022.

So EUR 75 million will be our realistic figure for 2022. Consequently, the typical pattern of Q4 has a very cash generative quarter is only true to a limited extent this year. And please keep in mind, many of the working capital-related movements are back end loaded in December. Therefore, we might see further cash flow distortions in the year-end as a result.

Now I will not go through every single market assumption that we have updated on the right-hand side. The main changes come from China, which looks more positive than we had expected and a weaker European environment. Overall, we now see 5% to 7% light vehicle production growth as a realistic figure for the full year.

And with that, I have reached the end of my presentation. And Andreas and I are now looking forward for your questions. But First, back to you, Heiko.

[Heiko Eber, executive]

Thank you very much. Thank you, Andreas. Thanks, Werner. [Operator Instructions]

Operator, we are now ready to take on the first questions.

[Operator]

We will take our first question from Christoph Laskawi with Deutsche Bank.

[Christoph Laskawi, analyst]

The first one will be on retrospective pricing in Q3 and Q4. Could you give us comment helping to quantify the amount that you had in Q3? Other suppliers have shown a fairly sizable margin support there and also for Q4? And I think you've reiterated the pass-through on the additional cost that you have? Could you just give an update on what was the pass-through share in Q3? And do you go 100% overcompensating in Q4?

And then so is the second block on energy and wages gross settlement into '23, do you have any comments there?

[Werner Volz, executive]

Thank you, Christoph. I guess I'll take probably both parts of your questions. And let's start with the pricing. And as we mentioned now during our last calls as well, well, of course, we see this huge price and cost increase in the size of or in the mid-size of 3-digit million EUR amount. And obviously, we're really trying hard to pass most of that on to our customers. While we probably have seen significant first impact in the second quarter. This is going to continue now or discontinued basically in the third quarter. And we indicated also that we at least want to achieve 80% recovery of the overall amount. And since we have made progress. I think I wouldn't -- we're not quite at 80% in Q3 which requires catch-up effects in Q4.

And this is what we have anticipated, but the current status on negotiations with our customers is indicating that we should see further progress in Q4 in order to achieve our dose and targets.

With regards -- yes, so I guess, Q3, it's probably in the range of 60% to 70%.

With regard to energy and wages, and your question was related to 2023. Right now, we're not providing any outlook or guidance for 2023, obviously, but we are expecting costs to further increase also in 2023 and especially energy and wages, we expect with probably, especially the wages, we expect with double-digit increases moving forward in 2023. And energy, I guess, nobody right now is really being able to predict the further development. However, yes, it's fair to assume that we will not see a price reduction on energy in 2023.

Is that covering the aspects of your questions, Christoph?

[Christoph Laskawi, analyst]

Just one brief follow-up on Q4 then. Outside of pricing, there are R&D reimbursements, I guess, driving your margin. Is there anything else that we need to be aware of as positive?

[Werner Volz, executive]

Well, I think we typically in Q4, we see a higher amount of reimbursement, R&D reimbursements and -- and I think also the market might be slightly stronger than still in Q3, I think these would be the major additional positive effects we should expect for Q4.

[Operator]

And we will now take the next question from José Asumendi with JPMorgan.

[Jose Asumendi, analyst]

It's Jose from JPMorgan. A couple of questions. I think the first one, I would like to hear a little bit more an update with regards to the collaboration with Renault and Infineon? And if possible, also if you could comment on the orders you're winning on thermal management? That will be the first one.

And second, as we think about ET, and the progression of this division. I know you don't want to give specific guidance for '23. But as we think about higher costs for energy or labor or the additional headwinds you may have in 2023, does this still allow for ET to improve earnings next year?

[Werner Volz, executive]

So maybe, Andreas, you could cover the first 2 questions.

[Andreas Wolf, executive]

Yes. I Yes. I mean, very briefly to Renault and cooperation of Infineon, it's progressing. I explained that working the strategic partnership with Renault means that we are working together also physically working together. We are sitting in a room, have key core members of the team here and are working towards those new products which we are basically codeveloping. So nothing really brand new now to be recorded. By the way, the same is true for Infineon.

The Infineon is a strategic partner on the supply side. Also here, I mean you know that we are preparing for the future with those huge orders reflecting also our increase in sales, which we shared on the Capital Market Day for electrification, we need to have access to, especially looking to the fixed technology, access to the capacities of the world. And that's why we have initiated also that exclusivity or the cooperation with Infineon, but nothing special to report.

We are on a regular basis meeting and updating the data. So nothing in a negative or positive way to report.

So under management, we share that news during the Capital Market Day, the EUR 1 billion, I also mentioned during my short introduction, that's reiterate that as a breakthrough because until then, we always said we have also govern management in our portfolio. We had all the orders more on the [ inverter, electric axle, [indiscernible] side, and now we could prove that also for the management, we are playing a major role.

All okay, profitable business with an international OEM. So nothing more to say here.

[Werner Volz, executive]

Then let me probably take the second part of your question. And reflecting on the headwinds coming from energy, personnel costs, material costs, raw material costs and reflecting that on ET, well, as we also see already this year, also ET is obviously impacted by such headwinds. And again, in general, that is our general major assumption and also our targets and objectives, and we're really fighting hard for that to get recovery for all of that from our customers.

I also indicated that in our China Markets Day already, of course, we're supporting and not just supporting we're confirming, of course, our direction moving forward. But that assumes that we will get recovery from our customers on these price on these cost increases. Again, so far this year, as I already indicated, we're on our way. However, we're not completely through.

And moving forward into 2023, obviously, we're not providing any guidance and upfront numbers for the next coming year. But it is fair to assume that these cost effects will also impact the upcoming year. And negotiations with our customers in all areas will continue to become necessary also for next year. So if we went through this year, I think we're will not be completely done, moving into next year. Also next year will continue to be challenging.

Yes. And obviously, our general plan. So from an operational improvement in EC, considering process improvements, design improvements, scale effects and so on, we're well on track, but we cannot obviously completely ignore the negative headwinds from the markets right now. Is that somehow answering your question?

[Jose Asumendi, analyst]

Yes. That's very helpful. Yes.

[Operator]

And we will take our next question from Sanjay Bhagwani with Bank of America.

[Unknown Analyst]

I've got a couple of questions. My first one is on ET. So when I look at, let's say, the 9-month performance of ET, sales is just slightly above last year and so are the profitability? So could you please confirm that the Q4, you are still expecting a step up? I think initially, the message is for somewhere around 15% to 20% full year growth for ET? So looking at the order pipeline and the seasonality, could you maybe still confirm that you're still going to see a step-up in Q4? That is my first question. And I'll just follow up with the next one, please.

[Werner Volz, executive]

Okay. yes, I'm happy to take your question, Sanjay. And yes, profitability and sales only slightly above prior year. I think we mentioned the reasons for -- so that's what, again, basically also coming from the overall market environment. Finally, also ET has been impacted by certain rare or shortage by the overall chip shortage and of course, also by the cost increase.

And also here, we're in the process of trying to get cost recovery in all aspects from our customers as well. And also, this is the assumption moving forward into Q4 for ET. And that is basically what we still can confirm right now. Again, we're now on the way for recovery. It is not a 100% recovery. But as I mentioned already, also for ET, but we should be able to confirm this is a step up in Q4 for ET as well. Is that...

[Unknown Analyst]

Yes. So looking at the product pipelines and the projects, you are able to confirm the top line as well, top line growth as well for ET? Is that right?

[Andreas Wolf, executive]

Yes. The very simple answer, yes. Yes.

[Unknown Analyst]

Then my next question is on the order intake. That is again very impressive and you've made -- you managed to get somewhere around $10 billion of orders in the first 9 months. Can you please provide some comparison like what sort of like the new orders this year, the kind of market share you have won? Or relatively, for example, do you see yourself as #1 or #2 in terms of win rate? If you can provide some color on that, please?

[Andreas Wolf, executive]

So first of all, guys that there is a question, Sanjay, related to the order intake. Yes, EUR 10 billion in 9 months is a real record order intake. That doesn't say that we are now stopping taking orders in, but that's really a nice one. We had the last 9 months.

Now I would not -- it's hard to say for me what does that really be on the market share side. What I can confirm is that our growth plans which we also shared back in mid of October in our Capital Markets Day means the EUR 5 billion for '26, and the EUR 10 billion to EUR 12 billion for the end of the decade, we can confirm. And with the EUR 10 million in the 9 months and the forecast for the next months, we have a relatively high probability and certainty that those numbers will come. Why are we better? And what is the take rate and market share percentages? That's a little bit too early to say. But with those numbers, we see ourselves ahead of competition currently.

[Unknown Analyst]

That is very helpful. And I've got one more question on the underlying business, if I may, please.

So what we see is a step up in Q3 for the underlying business and specifically quite an impressive margin for the ET core [indiscernible] in Q3. So when I see, for example, H1 underlying business was somewhere around 7.5% margins. Now this has gone up to 10% margins. How should we -- should we expect this to go further up in Q4, given that you mentioned a step-up in the pricing recoveries and also reimbursement along with reducing semiconductor bottlenecks?

[Werner Volz, executive]

A Very good question. And of course, very important, especially for underlining the performance of Q3. Here, we saw an improvement basically in our underlying core technologies business in all relevant areas. The 2 are -- I guess, the 2 major drivers are, of course, the market and the improvement of the overall market environment and the slightly reduced problems in the supply chain with chips now.

On top of that, of course, the improved price recovery in -- in Q3 in order to recover for the cost increases earlier this year. I think these were one of the major, major aspects besides some other issues related to some release of warranty issues where we have been able to positively negotiate with our customers. Is that answering...

[Unknown Analyst]

Should we expect this to increase in quarter 4 given these favorable trends along with the reimbursement of the R&D and also increase in the price recovery? That was my question.

[Werner Volz, executive]

Yes. Okay. Again, as I mentioned already before, as I say, that we are expecting further improvements moving forward in Q4 and on top of the increased recovery rates that we expect for Q4 also reimbursements will be further increase in the -- but typically, that's traditionally for our business in Q4 and should support our Q4 performance plan to step up.

[Operator]

[Operator Instructions] We will now take the next question from Giulio Pescatore with Exane.

[Giulio Pescatore, analyst]

I just want to go back on the topic of pricing, very briefly. I mean I think it's very important for us to understand what is the sustainable pricing and what is the fact that relates to previous quarters other -- some of your peers have been helpful in this regard, I'm trying to take us -- give us an idea of what is not linked to this quarter in particular. So can you give us a rough estimate of what was the fact that you felt in the quarter that did not relate to this quarter, but the cost you felt in previous ones?

And then the second one, a bit more technical on FX, just curious to know what you're assuming in terms of FX still for the full year. And then just lastly, quickly on the recognition technology sales, is EUR 1 billion of sales still possible, analytic number for 2023?

[Werner Volz, executive]

Sorry, Giulio. The line was -- looks really bad, just to make sure we got the question.

So first part was what portion of the pricing path on to the customer is sustainable? Right?

[Giulio Pescatore, analyst]

Yes. Yes. So how much relates to previous quarters? And yes, just a rough idea.

[Werner Volz, executive]

And the second part of the question was on the EUR 1 billion electrification sales is still realistic given the year-to-date.

[Giulio Pescatore, analyst]

Yes. And then there was one on FX, just quickly, what are you assuming for this year?

[Werner Volz, executive]

It's a tough question. Your first question, Giulio. And of course, our goal is to negotiate with our customers in order to get sustainable price increases. But it is a valid question and to a certain extent, we have not achieved to have 100% price increases on a sustainable basis moving forward. Some of the additional monies that we receive are either onetime payments or timely limited. Nevertheless, of course, we are already in the process in negotiations for 2023.

So in order to carry that forward and eventually get these increases for 2022, sustainable into 2023.

[Andreas Wolf, executive]

I want to add on that, Bernard. Just to explain a little bit the background of how 2022 was negotiated. We always talk about the full year. So whenever we sometimes mean here quarter 3, quarter 4, it's just the impact, but reflecting recovery for the full year. In some cases, negotiations went took a little bit longer time wise and then translating the cost increases into price increases is not possible because then you have to basically combine the down payment with the price increase looking forward.

So we have a mix of down payments, price increases so that the -- everything which is possible to basically so give us an incentive on the cost increases. But they are all linked the year 2022, even though we have, in some cases, price increases, they are not automatically agreed for '23, '24 and so on. So whatever the solution was to give us money price-wise down games, et cetera, we have to negotiate for '23 again.

Hopefully, that answers your question.

[Giulio Pescatore, analyst]

Yes [indiscernible] sales, you will also ask maybe to just complete the second part.

[Andreas Wolf, executive]

Yes. But what I had in my speech. We are convinced that the EUR 1 billion is realistic for 2022.

[Giulio Pescatore, analyst]

And on the fact just quickly, please?

[Werner Volz, executive]

Sorry [indiscernible] Well, the overall tax situation. I think in general, we're making progress in applying our new tax regime, I guess, on a global basis, driving our tax rate down. If you refer to the tax cash issue that we were enjoying this year that relates to VAT tax receivables that we had in Mexico and still have that is related to spin-off effects still in 2019, where we realize certain tax benefits back then, which we're currently able to recover. And the size, it's a mid double-digit million EUR amount that we received as recovering in the third quarter, which, on the other side, is helping, as I explained or tried to explain to compensate for the increase in our accounts -- our working capital coming from inventory and accounts receivables. Is that answering?

[Giulio Pescatore, analyst]

Yes, I apologize for the bad line. My question was on foreign exchange, the impact you're assuming in your guidance for the top line?

[Werner Volz, executive]

Okay. Apologies. Okay. Sorry. Well, in Q4, in our actual Q3 numbers, we have a tax and FX fixed impact of roughly 7 percentage points increase reflecting on the increase. And I think right now that might change slightly, but also might be potentially effect for Q4 moving forward.

Yes. And the main drivers are USD and [indiscernible] obviously.

[Operator]

And we will now take the next question from [ Felix Kenning ] with Goldman Sachs.

[Unknown Analyst]

First question is a quick clarification on the pricing. When you mentioned that you -- that the pricing only covers 2022, does that just mean anything -- any further cost increase in 2023 means you need to renegotiate? Or does it also mean that payments or the new payments to go on into 2023, enterprises reset again? Just to clarify.

My second question is a more long-term one on the reaching the breakeven profitability in your electrification business. given that I think the -- most of the R&D spend for those products is more generic than customer specific? Is it fair to say that most of the R&D spend fairly early and then the improvement in margins is should accelerate rather towards the late parts or end of 2023 as we think about the path to profitability for that segment?

[Andreas Wolf, executive]

Maybe for the pricing question, yes, because, I mean, we were negotiating 2022 and not 2022 and the next year is because we have very specific details about cost increases on the material side and other cost components, which will then translate into price increases down its whatsoever for 2022. So logically, that means I think that's quite normal for the industry, that price -- new prices for 2023 have to be renegotiated independently of how it's -- the money came in 2020.

For some customers, they already indicated, that's now the new base. We will carry forward that in 2023, but more generically speaking, almost focused on 2022, and now we have to basically extend it into '23. Our goal is to translate it directly into price increases and not negotiate and any down payments for the year.

[Unknown Analyst]

R&D and breakeven on the breakeven question.

[Werner Volz, executive]

Well, maybe I take that -- right now, we don't have any reason to not believe and not to confirm our midterm breakeven target. But again, also here, as I referred to in our Capital Markets Day presentation. That requires, of course, 100% recovery or recovery on large extent for this significant cost increases.

And with regards to the R&D spend, while we have a certain project related, which is typical for our business. And due to our modular and standardized product design. Of course, we are spending some of the R&D upfront right now as a base development, which is basically not repetitive.

On the other side, if you expect R&D and the overall R&D amount or the total R&D spend to be reduced, I think this would not be a bad assumption because the overall absolute amount probably might continue to slightly increase in order to support our significant growth in the future. But in relative terms, of course, our R&D rate is expected to drop.

[Operator]

We will now take next question from Edo Spina with HSBC.

[Edoardo Spina, analyst]

I have 2 questions. The first on the order book in general and specifically on electrification because orders are measured in EUR, what the pricing assumptions are you making for these new orders? Can we expect an increase in the order book in the future if you can push through more price increase or you're already assuming higher pricing for the new orders?

And the second question is on noncore sales. it was higher than I expected. I just wanted to ask if you think there is a scenario in the mid term where the noncore sales remained higher than you expected, and if that would have a dilutive impact on the group margin just mathematically for the midterm?

[Andreas Wolf, executive]

Maybe I'll take those questions. I would start with the second one. No scenario change on the noncore. We shared the time lines, I think also during the Capital Markets Day where we said when is what swing down which percentage. So no change, yes. We will see significantly dropping the sales down next year already and the years after. So no change.

On the order book, it depends. So first of all, in many cases, we are already quoting with and an increased material price portion, which means translated into higher prices translate into higher sales. And therefore, the order book will not change and will not increase once those numbers are then corrected. They are already in a good shape.

But looking to all orders which we have already the order book -- they are still based on old, how can I say, old material prices on cost base. Here, we think they will be adjusted accordingly over time. That's, by the way, the assumption for our future. That's what Werner first just said that looking to breakeven for ET whatsoever, we always assume that cost increases are also compensated.

[Operator]

[Operator Instructions] We will now take the next question from Himanshu Agarwal with Jefferies.

[Himanshu Agarwal, analyst]

Himanshu from Jefferies. The first one is on the pricing. And apologies if you've already answered this question because I had a brief interruption. So yes, can you sort of comment on the Q3 -- in Q3 pricing, how was there any retroactive pricing benefit related to first half? And Also, you have given us the EUR 180 million gross headwind related to cost inflation, is it possible for you to tell us what is the Y-o-Y increase so that we can estimate the price increase in Q3?

And the second one is on the China. So I appreciate the growth in Germany and North America. I think China was impacted by the lockdowns in Q2. And yet, we are not seeing any acceleration in China even -- can you just give us some color related to that? And I understand in ET, you had a brief call for 2 weeks for ramp-up, but in other divisions.

[Werner Volz, executive]

Well, probably thank you, Himanshu and for the question. And indeed, we were talking about the prices already. But again, I think the impact in Q3 on recovery to our pricing that is well between 70% and 80%, yet you know that our goal is to achieve at least 80% and recover for 80% that means that our Q3 is still below our expected level, which also means and requires catch-up in Q4 for which we have good indications coming from our sales organizations and from our customers exist on current ongoing negotiations.

I think we should -- and therefore, we're comfortable to see this catch-up effect in Q4. Is that answering the first part of your question? Himanshu?

[Himanshu Agarwal, analyst]

Yes. And can you confirm, was there any retroactive benefit in Q3?

[Werner Volz, executive]

No, Actually, we're a I cannot -- it is a complicated process in this recovery. So to a certain extent, yes, there are retroactive recoveries included. But overall, I think that is important, we were talking about midsized 3-digit million EUR amount that we basically suffer in cost increases. And again, we try to get at least the recovery of 80%. And in the first quarters, we haven't achieved the 80% yet that requires catch-up effects in Q4. And this is what we again confirmed that we will see these catch-up effects in Q4 due to our existing status in negotiations with our customers. So is the business make it clear enough for you?

[Himanshu Agarwal, analyst]

Yes, it does.

[Werner Volz, executive]

Yes. Let's talk about China. I just like to repeat the question, and maybe you correct me if I didn't understand it or I didn't get it right. When will we be able to profit from China development again. And Obviously, the current main drivers right now in sales is North America and Germany. Was that your second part of the question?

[Heiko Eber, executive]

We think this is a yes.

[Himanshu Agarwal, analyst]

Yes. When could we see the growth from...

[Werner Volz, executive]

I think passenger vehicles, we already see the recovery right now, and that is already visible. And also here, we will benefit from this trend. On the other side, of course, we have strong business in China, especially in China, with commercial vehicles. And this market is still very difficult.

And on the last part of the question, yes, I think right now, for the time being, the German and North American market, respectively, European markets, these are, of course, the main drivers right now.

[Operator]

There are no further questions. So I will turn the call back to Heiko Eber for closing remarks.

[Heiko Eber, executive]

Thank you very much. So since we have no further questions, all I can do is say thank you to the operator. Thank you to our speakers, Andreas and Werner. And of course, thank you to all you guys on the phone for your time and your interest. As always, if there are more questions coming up after our today's conference call, please free to reach out to us.

So thank you very much, and talk to you soon.