Volvo Car AB (publ.) (VOLCARB) Earnings Call Transcript & Summary

Good morning and welcome to Volvo Car. We are here to present our third quarter financial results coming to you from our headquarters in Gothenburg. My name is Ron Banerjee. And I'm joined this morning by our President and Chief Executive, Jim Rowan; and our Chief Financial Officer, Johan Ekdahl. At the beginning of this livestream, Jim and Johan will walk us through our third quarter performance, after which we will open it up for our live Q&A. [Operator Instructions] With that, let me invite Jim, to walk us through our Q3 performance. Jim.

Thanks, Ron. Good morning, and welcome to our Q3 2022 financial results. Despite multiple headwinds, demand for our products continue to be robust globally. Our EBIT margin, excluding JV & associates came in at 4.4% EBIT, and with a JV & associates 2.6%. We constrained production and some cost increases through the quarter, COVID restrictions and power outages in China, spot purchases and prices for semiconductors, higher raw material costs and higher logistic costs. These coupled together to put pressure on our gross margins. And demand, as I said earlier, remains strong across all the regions. If we look into the key financials, retail sales were down slightly at 8%. However, revenue remained incredibly strong, plus 30% driven by price and also by product mix. As I alluded to earlier, our EBIT margins came in at SEK 3.5 billion, with excluding JV & associates, which is 4.4%. And Johan will take us through the financials in a little bit more detail in just a moment. Move into your strategic ambitions. Despite these multiple headwinds that we've saw, we are still tracking towards our mid-decade ambitions. And let me just talk through those quite briefly. We remain on track to sell 1.2 million cars by the mid-decade. 50% of those cars will be electric, 50% of those sales will be online. And we expect to have our EBIT targets of between 8% and 10% within that timeframe. We're also tracking towards a 40% reduction in CO2 reduction per car when we align that to a 2018 baseline. Let's look at those transformation steps towards the mid-decade ambitions. Demand for recharged cars is very high, but at this point in time and for this quarter, we fell short because of constrained components, and specifically geared towards our recharge products. This meant that our recharge products came in at 25% of total sales with full BEV at 7.4%. That would have been much more but for the constraint on more specific parts. Our CO2 reduction per car came in at 11.8% which very much keeps us on track towards those mid-decade ambitions of 40% reduction. Where we have launched online sales and the markets that we have launched online sales these came in at 6%. Again, that is on target with expectations. And as communicated on September 21st, Volvo Cars will reveal our next new flagship, fully electric SUV, the Volvo EX90 on November 9, and that is another milestone for the company as we approach the back end of this year. If we look to sheet of recharge cars, that has been affected by the supply constraint. So we saw that reduced from 31% to 25%. However, when you look at as those supply constraints start to free up within the third quarter and we look at September in isolation, then we actually see that BEV sale accounted for 13% which is the highest in the history of the company. And our overall recharge is tracking to 31% when you look at September, it's an isolated month within Q3. And of course, that bodes well for our ambitions for Q4 and beyond. And with that, let me hand over to Johan Ekdahl, who will take it through the financials in a bit more detail. Johan.

Thank you, Jim, and good morning. Okay, let's then go through the financials a little bit more in detail. Retail sales volumes down 8%, which is then driven by the production constraints, especially earlier in the quarter, based on the lockdown for COVID in China, the power cuts in China and the heat waves and also a continued supply constraints on certain components. However, we did see actually turning points where we had a year-over-year increase in retail sales in September. So this has been gradually improving also during this quarter. Revenue, very strong, 30% up. Strong pricing on the back of the good demand, strong mixes of cars. We also have seen a tailwind on FX, especially on the U.S. dollar and also that we have an effect from the contract manufacturing of cars than for Polestar. EBIT at SEK 3.5 billion or 4.4% in the quarter, a decrease from last year, which is then driven by higher cost of raw materials, especially on electrified cars and on the lithium prices, but also on high cost for spot purchases of semiconductors and also a higher euro FX. We'll come back more on EBIT just shortly in detail. Cash flow, positive. Operating and investing cash flow in the quarter, SEK 3 billion, which is also somewhat of a turning point here compared to the previous quarters this year. So revenue, again, very strong, up 30%. We have an effect from increased wholesale volumes during the quarter. We do see continued good pricing on the back of the high demand. We do see a positive sales mix effect and also a very strong FX, especially on the U.S. dollar, which has been contributing to almost SEK 6 billion. On top of that, we have contract manufacturing for Polestar contributing SEK 6.5 billion in the quarter. So all in all, strong revenue. EBIT then, we also here see a positive effect from volume and sales mixes and also on pricing. FX, virtually flat. We have a positive effect from U.S. dollar but we also have a strong euro rate which then makes this offset, as you could say, to more or less flat. In addition to that, in this quarter, we have seen increased costs for raw material and freights. Raw materials and effect from the flow-through of the high spot prices during the second quarter where we do see a certain lag in time and also continued high prices on battery materials, especially on lithium. In addition to that, we have seen high cost for spot purchases on semiconductors during the period. And we also have some more temporary effects on the geographical mix, which is then especially a lower U.S. mix than usual due to certain logistics issues towards the end of the quarter. That is something that we’ll now normalize during the fourth quarter. And including JVs & associates, EBIT at SEK 2.1 billion, which is then affected SEK 1.5 billion of results from JVs & associates in the period. EBIT development over time. As we see, we have been quite stable over time. Then we have this big uptake in Q2, including JVs & associates which is then, of course, driven then by the effects from the listing of Polestar. And then as I just showed, we see a decline in the third quarter for the reasons just mentioned. BEV margins, deterioration during the quarter, which is driven by several things. One being then the increased cost for the raw material, especially batteries and driven by the lithium prices. But we also -- and that stands for, say, around half of this effect. But then we also see some other more temporary effects, especially on FX, also driven by the low U.S. mix that I just mentioned and also the U.S. dollar effects, which further affects the prices for batteries. And then we now go forward into the fourth quarter, we will see a more normalized geographical mix, and we will also see price increases further flowing through into the fourth quarter and also even further into 2023. On liquidity, we are at a solid liquidity level. We have a positive free cash flow of SEK 3 billion in the third quarter, mainly driven by a positive working capital development now in during this ramp-up phase of the gradually improved production situation. We see also included in investments is SEK 3 billion of what we have called pre-IPO transactions, which in this case, is a shareholder loan to our JV with Geely, Aurobay in China. So the underlying operating free cash flow is actually even better. So with that short financial summary, I will leave back to James to take us through the summary of the quarter.

Thanks, Johan. Okay. So in summary, our EBIT remains robust and stable across the globe. Overall semiconductor situation is better, but the continued lockdowns in China caused by COVID and some of the heat waves have impacted our production. If we look at production for the year especially if we focus in on Q3, and production of 145,000 units is up 34,000 units year-over-year, with September BEV production being the highest in our history. Recharge production in Q3 was 37%, whereof 14% of that was fully electric. The effects of the lithium prices will continue to affect or put pressure on our raw material and overall prices as well as gross margins as we go into the fourth quarter. As we continue to put in cost measures to focus on productivity and efficiency to offset some of those additional costs. The additional pricing actions that were put in place are further to materialize in Q4 and beyond. And again, that will have a positive effect. Now assuming that there is no further major supply chain disruptions, production wholesale and retail are expected to grow in the second half of this year. However, we do expect a slightly lower wholesale volume than in 2021. And that means that we'll be tracking towards double-digit BEV sales for the full year as originally planned. So despite all of the uncertainties, and they remain high, we are fully focused on and remain fully committed to a long-term strategic objectives as outlined earlier in the call. So then one last point, and that is the EX90 reveal in November 9th. This is the reveal of our first flagship product, which will be our flagship EX90 that we are excited to bring to the public and announce that on November 9th. With that, I will hand over to Ron, who will now take us through the question-and-answer session.

All right. Thank you for that, Jim. So we are all settled in now to kick start the Q&A session. For that, let me invite to join Jim and Johan, John Hernander, our Head of Investor Relations. Good morning, John.

Good morning, Ron. Thank you.

[Operator Instructions] So the first -- let's take a caller. This is George Galliers from Goldman Sachs.

So the first question I had was just on semiconductors. You mentioned that the constraints are continuing to improve gradually. Could you talk a bit about what -- how much constraint you see in the fourth quarter and also the first half of next year? And also what you're seeing in terms of semiconductor pricing? And then with respect to semiconductors, could you just remind us how you purchase them? Do you purchase them directly from a Tier 1 supplier or indeed a semi manufacturer? Or are you buying them from within the broader Geely Group? And then the second question was just with regards to the loans at Aurobay. Could you just confirm, was that planned, and as described during the IPO process, or is that an incremental loan above and beyond what was previously communicated?

And maybe I'll start off and I'll answer the first 2 parts of your question, and then I'll hand over to Johan. He can take you through the conversation with Aurobay. So semiconductors, what we've found increasing through the course of this year is that semiconductor availability has become better. But however, as we approach the back end of the year, we still see sporadic supply constraints. And when that happens, then we need to play in the spot market in order to secure those parts. So the trend line is good and as much as we are having to play less and less in the spot market purchases, but that is still prevalent right now in Q3. I expect that to be the same in Q4. And then hopefully, as we go into 2023, we see that trend line continue and we need to spend less and less money on spot market purchases for semiconductors. An answer to your question in terms of how we buy those as a mix, on some semiconductors, we by directly from the manufacturer. On some of those, we buy those semiconductors through a subassembly. So we have subassembly components that use those semiconductors. And in that case, we rely on those manufacturers who do the subassemblies to buy those semiconductors, and then install them in the subassemblies before shipment to Volvo. We're also winning in on that as much as we possibly can, and helping those subassemblies companies to actually procure the silicon and the semiconductors where we think we can help. And in some cases, that's where we make the spot purchase buys. We secure those semiconductors and then we ship them to the subassemblies and they produce the final product or the final subassemblies get it to us. We don't -- this isn't related to Geely. We do all of this on our own through Volvo procurement. I should probably just add to that, and in order to build the robustness of a supply chain architecture and infrastructure, we are adding more and more analytical tools to our supply chain capabilities so that we get more visibility and a bit more granularity quicker in the process to try and alleviate some of the -- because obviously, the sooner you see these issues, the sooner you can react. And either you're in the spot market quicker and therefore, paying less money or indeed, you can actually navigate past that without having to go into the spot market in the first place. Hopefully, that answers the question, and I'll hand over to Johan, who can talk about Aurobay.

Yes. And regarding the question on Aurobay, the short answer is, this was fully in accordance with plan on the financing Aurobay. So it's nothing incremental on that. So yes, that's the short answer.

Let's take another one. This comes in through chat, this is by [ Valdimar Dinrock ]. And Valdimar is asking, how does the stop in production in Torslanda next week affect the production as a whole? Does it lower the target for the full year?

Yes. So the stop in production in Torslanda obviously, would’ve known that was coming. So that's already baked into the full year numbers at this particular point in time. And of course, if you're familiar with the manufacturing process, sometimes it's easier rather than to run the facility on a half day basis or a sporadic basis, it's sometimes much more effective and efficient to close the factory for a couple of days until you have sufficient supply of components and then run that at full speed, which is generally when you can run the factories in the most efficient manner. So that's really the reason behind the reason for the closure. And also just to give you clarity, that's already baked into the year-end numbers. We don't expect to see any more closures unless there’s some major discrepancies that we don't see right now between now and the end of the fourth quarter.

Let's take the next caller, and this is Mattias Holmberg from DNB.

First, I would be interested to dig a bit deeper into the quite high volatility in revenue per BEV car that you show on Slide 12 and also the quite a significant drop in gross income, which I think declined from 31% in Q2 down to 21% now in Q3. A bit surprised to see prices come down sequentially when you talk about price increases. So perhaps there's something I'm misunderstanding here. And also perhaps comment on how quickly you expect to be able to reestablish the gross profit or gross margin for the BEV segment with your current visibility on selling prices and costs.

If we start with the Q3 then on BEV, it's several different reasons. One being, of course, higher cost raw material, especially lithium that is currently on a very high level. So that has an effect, I would say, pretty much half of the effect that we see between Q2 and Q3. Then in Q3 isolated, we have had some, let's say, more temporary effects, which is a mix of FX and geographical mix of sales, which means that we do buy batteries in U.S. dollar, but we have had an unusual low U.S. mix on the BEV sales during the quarter, which means that you have an accelerated FX effect due to that fact. So the drop that you see in revenue is not by any means that we have lowered prices in absolute for the BEV, it’s rather an FX effect as well. So I think looking forward, we will see a more normalized geographical mix into Q4, which will offset this effect that we see in Q3 somewhat. We do see, however, still, of course, high raw material prices short term based on the lithium prices, et cetera. But we do believe that, and so does the market and the intelligence, that we have that the lithium prices gradually will come down. They are at the peak right now. So I think that we will short-term still see probably higher raw material prices, even though we have some other effects that will be not as severe in Q4 and forward as we saw in Q3. We will also see some additional pricing increases flowing through into Q4 and even more into '23, especially in Europe, where we have made price increases earlier during the year. But due to the long order book and the lag in time, if you will, we will see a gradual flow-through of that into Q4 and then even more so beyond that.

If I may, just a quick follow-up or actually a second question. I'm a bit interested to hear more in how you're thinking about still maintaining the mid-decade addition of 1.2 million cars sold and more precisely, what you mean when you say that you're tracking towards them? I mean, when I look at IHS having cut 2025 -- global core costs are almost 10% just this year. I'm a bit curious to hear what market assumptions you use in order to reach to 1.2 million or if you simply assume that you will be able to compensate for the weaker market with even more market share gains.

So 2 parts to that. First of all, we need to look at demand, and demand for our products right now are incredibly strong. Perhaps more importantly, the demand for our BEV and recharge products, but especially the BEV products that are strong. And actually, we see that as a global phenomenon. If you look at the whole industry as a whole, from January to August, ICE demand has been down by 19%, whereas BEV demand has gone up by 74%. That's just an industry-wide number. And that's important for us because, of course, our strategy relates to taking more market share out of ICE as we build up our ICE portfolio. So far, we've really only had the XE40 and the C40 product and our BEV range. We'll announce at EX900, in a few weeks' time. And then, of course, we've committed to releasing a brand-new BEV product every year until the mid-decade for the next 4 or 5 years. So that on its own as well as, and then next year, we've already alluded to that we will release a new smaller SUV which we expect to be a good volume product for us as well. When you add all of that together, then you get a whole range of products from the smaller SUV all the way up to the flagship EX90 SUV. You get them in the BEV format and you get them released before those mid-decade ambitions of 1.2 million cars. In addition to that, you get an explosion of demand into the ICE -- sorry, into the BEV product category. And those combined, I think with the technology that we're bringing to the market gives us a pretty good shot in those mid-decade ambitions.

Maybe to add to that as well, I mean, we don't think that we enter potential recession at the overheated level. I mean, you've seen the supply being restrained over the last couple of years. So I think that we -- not only as we allude to include market appreciation in our ambition to grow. But one should be reminded as on the -- absolutely of where we start at the moment, I think.

Yes. And just to pivot on that. There's been -- you know, because there's been a lack of supply into the market. The people that are coming into the market now are probably going to come in on the BEV side because that's the new technology, that's the technology that they’re going to invest in for the future, and that's where we'll have the most constant to have less residual value risk. So all of that, us having products placed at the smaller SUVs all the way up to the flagship SUVs and have a good range of products in a market which is expanding in BEV, I think positions us pretty well to meet those mid-decade ambitions.

So let's take another question on -- via the chat. This comes with from [ Carlin Lander ] in Dagens Industri. Why has online sales decreased from 8% to 6%? And she has another question, how will the rising energy prices affect Volvo cars?

If we start with the online sales, we have, as you say, 6% in the markets where we have launched that. I think that is, to a large extent, an effect of the production and supply situation where we -- for several reasons. One is that we have had lower inventory during this period, which means that is -- then it's not really supporting in that way, the online business model. The second is actually prioritization of cars during the limit -- when we have a limited supply, we have actually prioritized other channels to some extent, that where we have sort of revenue recognition and cash flow, et cetera, due to the limit in supply. So it's, to some extent, deliberate. So we are still comfortable that we will -- we see a good growth in that channel going forward when we have a more normalized supply.

And just to be able to clear on that, Carlin. So we have -- could have higher sales than 6%, quite easily. We chose to push those vehicles to different channels for financial purposes which we think is the right thing to do. But there is demand that was coming in on online sales which is much higher than the 6% even in the limited markets that we launched an online sales capability.

And there was another question on the rising energy prices and how that's going to affect or could affect Volvo cars.

I think there are 2 things. For our own operations, of course, we will see an increased cost range, but that is not by any means, the biggest cost we have. So I think that that effect is somewhat limited even if the prices are high. But of course, we do see indirect effects rather on effect on raw material prices, et cetera, which is, of course, to a large extent also driven by higher energy prices. And there, we have seen in the quarter that we have had higher prices for raw material. But in our own operations, the exposure to energy prices is not that significant.

Let's take the next caller. This is Jose Asumendi from JPMorgan.

A couple of questions, please. Can you talk a bit around the -- your order book, whether you're starting to see maybe the economic uncertainty that we are facing. Is it denting with the other backlog or you see some uncertainty? And can you also please comment on the level of inventories that you have across different regions? That’ll be the first one. Second question, please. On the profit bridge, the other bucket is quite substantial. Can you provide more color on the other category? And how should we think about this category into the fourth quarter, please? And then can you please comment like overall, how do you think about managing pricing power into next year and maintaining the strong level of pricing power, low level of discounts structurally strong for the next decade?

Let me take the first -- I'll take the first part and the last part of that question and then maybe Johan can speak about the inventory level around the globe. So it's a great question because you look at that ourselves. So when does demand was rising, energy prices rising inflation? When do you start to see consumer sentiment dropping off? And when do you start to see large order cancellations or the order book or the new order start to slow down? And we're looking at that on a regular basis. At this particular point in time, Jose, we don't see any reduction of demand. And in fact, what's really encouraging for us is that the demand for our BEV and our recharge products is incredibly high, which is great because that's the future, that's -- the strategy of our company is that we're adding capacity, of course, for our electric products. We keep a very beady eye on that reducing consumer sentiment. And at this particular point in time, globally, we don't see any softening of demand and we don't see any large-scale cancellations of existing orders. So that's -- I guess that's the good news. In terms of the pricing, we think we do have scope for additional pricing power. I think the brand is strong and the brand attributes are working well in the markets that we're in. We have raised prices already, as you know. And in fact, as Johan alluded to, not all of those price increases have yet come through. The cost increases came to quicker than some of the price increases. The reason for that, of course, is because we have a large backorder book. And so it's only on the new orders that we could leverage that new pricing. So that will start to flow through in the fourth quarter and then, of course, in the first quarter as well next year. So you'll start to see those higher prices kick in in some of the markets that we put prices in later than the other markets. In Europe, we acted quick. In some other markets, we're a bit slower. So that's the way I see the pricing power and the demand profile. I'll let Johan talk about the inventory levels across the globe.

Yes. And we have -- I mean, due to the production constraints we have had -- we have been at very low inventory levels for some time. We have seen an increase in inventory slightly during Q4, which is mainly driven by production inventory, which is due to the fact that we are seeing a gradual improvement of production during the quarter. So that has increased inventory. When we see a gradual improvement both in production and sales going forward, I think we will see a gradual increase in inventory levels, not for any other reason that they are at an extremely low level currently. So when things gradually normalize, we will see a slight increase in inventory. I mean this quarter, we have seen it mainly in production inventory, not in inventory of new cars mainly.

And there was another question on the profit bridge that if you could explain that a bit more, what led to the decline in the profit in this quarter?

Yes. If we look at the profit this quarter, I think that we have a few main items. As we have said, we have had an increased cost for raw material, which is partly a flow-through from the high spot prices in Q2 where we have seen the peaks in many raw materials. We've also seen a continuous high level on raw materials for electrified cars, mainly driven by lithium prices and batteries. We also have seen, as we have talked about, the high increased cost for spot purchases of semiconductors due to the continued although improving supply constraints, and also increased costs for logistics. On top of that, we've also seen on FX that on revenue, we have a good tailwind on the U.S. dollar, which is contributing quite a lot to our revenue growth. However, we also see an increased euro rate, which has more or less offset that effect if you take it from a profit perspective. So on EBIT level, FX effects are more or less flat. Okay, those are the main effects. And in addition to that, if we look at it from an FX perspective in the quarter isolated, we also have, as I said, a lower-than-usual U.S. dollar sales mix, which also affected from an FX perspective due to the benefit we would have had on the high U.S. dollar if that mix -- and that will normalize during Q4.

We have another caller on the line. Let's bring in Agnieszka Vilela from Nordea.

So I just wonder when it comes to your order books, how long are they today? So when can you deliver your cars basically? And has the time to delivery expanded given your problems for the production? Start with that.

I’ll start with that and Johan can add some details. So we don't actually release the amount of orders that we’ve got and it's different in different regions, of course, and it's definitely across different product models. Again, I'm going to come back to the demand cycle, piece. So even though we have increased lead time as we call between order and delivery of the product itself. Again, we're not seeing any demand in short or reduce as an extension of those re-kind deliveries. And by and large, I think the industry has seen extend retinas well. So maybe that's part of the reason for that. And whilst that's increased over the course of probably the last couple of months, now we're starting to get into a situation that we're starting to see maybe for the first time that some of those lead times will come down for certain models and as model by model and country by country. Of course, if you're manufacturing a product in one part of the world and you're shipping it logistically to another part of the world, then you need to bake that into the lead time, whether if you manufacture and supplying in the same geography, then, of course, that will tend becomes considerably shorter. So you need to look at on a lead time by lead time and product-by-product basis.

And then another question is on your new product, EX90. I don't know if you've been talking about the selling price already. I just wonder what kind of premium do you need to have towards EX90 given the fact that you have so much technology in the new products and in order to make this product profitable for you?

Yes, no we haven’t release piecing on that yet. Suffice to say that we think that that product for the technology, the market it's in is competitively priced. It’s a [ super-fueled ] engineering and innovation, and we’re really excited to release that in a couple of weeks' time, and we think we're very optimistic that we'll price that product to be very competitive in the marketplace.

And then the last one from me. I can see that the contract manufacturing the quarter revenues reached SEK 7 billion. And when I look at the poster deliveries of 9,300 cars, that would mean that the kind of contribution by car you gain in the quarter was at about SEK 700,000 compared to below SEK 300,000 before. So can you explain what is happening and what kind of assumptions should we make going forward?

What I will say on that is that we don't comment on the specific margins on that. We have a contract with Polestar where we have selling the cars on arm's length. The margin in average on the contract manufacturing cars is slightly lower than on our normal wholesale. We also say that this kind of sort of mathematics is not necessarily showing the exact margin of the cars because there is a certain lead time between our production, our sales to Polestar and Polestar retail deliveries to the market. So I would say it's more complex than just doing that mathematics. And I will not comment on that specifically. So I think the margins on the cars from us to Polestar is it has been the same more or less over time during 2022. It's not that it has been any difference in Q3.

And you don’t have any kind of license revenues, special license revenues that you're booking this quarter or?

No, nothing material at all on license revenues this quarter, no.

[Operator Instructions] So let's take a question then that’s coming from the -- via the chat. With the higher lithium prices, are we -- is Volvo Car sure electrification is the right technology for the future?

Maybe let me start, Johan, and I’ll kind if handover. So at the end of the day, my opinion is the technology wins at the end of the day, it usually does. In fact, I think you can see it always does. And when you look at the -- we see that proof point now in the marketplace where we see ICE reducing by 19%. We see BEVs increasing by 74%. That was a massive switch in even a year ago. And so when you have a technology which is quieter, which is no vibration, where there's less servicing for the customer, where there's less servicing cost for the customer and with the zero [indiscernible] emissions and it's much better for the planet, then that combination is a very, very powerful combination that states that this is the technology of the future. And these are the technologies that you need to invest as a next-generation mobility company. So I'm increasingly confident that we have the right strategy. Yes, there's some lumps and bumps right now. There's a lot of turbulence. I think we could safely say that every industry in the world right now is suffering some kind of form of turbulence given all between there's dreadful water in Ukraine to increase energy prices, raw materials inflation, COVID lockdowns in China, semiconductor issues. When you put all that together, that's quite a turbulent environment. And of course, we're having to navigate through that. But as you come out the end of this, and we will come at the end of this in a relatively short period of time, hopefully, as lithium prices start to stabilize as well, then those who have position themselves well and kept investment in the new technologies for the future, I think, will be the stronger players in next-generation mobility, and that's exactly what we expect to be. And that's why I'm confident that this is the right strategy.