KONE Oyj (OTCPK:KNYJF) Q2 2022 Earnings Conference Call July 20, 2022 5:30 AM ET
Company Participants
Natalia Valtasaari – Head, IR
Henrik Ehrnrooth – President and CEO
Ilkka Hara – CFO
Conference Call Participants
Daniela Costa – Goldman Sachs
Jeff Sprague – Vertical Research
Andre Kukhnin – Credit Suisse
Miguel Borrega – BNP Paribas Exane
Klas Bergelind – Citi
Alexander Virgo – Bank of America
Andrew Wilson – JPMorgan
Guillermo Peigneux-Lojo – UBS
Martin Flueckiger – Kepler Cheuvreux
Natalia Valtasaari
Good afternoon, and welcome to KONE’s Second Quarter Earnings Call. My name is Natalia Valtasaari, and I’m Head of Investor Relations here at KONE. I’m very pleased to be joined here today by our President and CEO, Henrik Ehrnrooth; and our CFO, Ilkka Hara.
As usual, Henrik will begin by talking you through the key developments in the quarter, both in terms of our financial and business performance, but also what we’re seeing the markets. Ilkka will then deep-dive a bit into the financials and Henrik will wrap-up with our market outlook and our guidance for the year before we then move into your Q&A session. [Operator Instructions]
With that, Henrik please.
Henrik Ehrnrooth
Thank you, Natalia and good to have you all online. Our second quarter was clearly a mixed quarter. It ranged everywhere from significant impacts from COVID lockdowns in China, to an excellent performance in our services business. So, many different situations in the quarter.
So, if we start with the highlights of Q2 2022, clearly, the lockdowns in China had a significant impact on our deliveries, although our order development in China was robust, which is clearly a positive.
We again had an excellent quarter in our services business and what is positive here is that the good growth in services overall was driven by both pricing as well as volume growth. So, we’re making good progress here again. Our actions to improve our profitability are progressing well and clearly remain a top priority. Ilkka will talk a little bit more about how we are progressing here.
So, some of the key figures for Q2 is that the orders received were just slightly up year-over-year in comparable currencies adjust over €2.6 billion. I think in the environment, I think is actually quite a good number.
Our orderbook is clearly at an all-time high at exactly €10 billion and that’s up 12.2% year-over-year in comparable currencies. So, clearly, that’s very strong and gives us good situation going forward from here. Sales at €2.55 billion, now down 15%, and cleared here, as we had announced already impacts on China was quite significant.
And given the impact of the COVID lockdowns, our operating income declined at 48.5% to €189 million and our adjusted EBIT declined by 44% to €209 million, giving us a margin of 8.2% compared to 13.3%. It is clear that this type of margin is not okay to us and it’s clear that we want to improve it quite significantly.
Our cash flow, €166.6 million, down from the exceptionally strong level of over €500 million last year. But as we always say one quarter is a short period of time. And now, we have six months behind us, which gives us a little bit more perspective.
From orders received perspective in this type of environment, we grew now at comparable rate at 5.2% to just over €5 billion, I think is actually quite a good number.
Sales close to €5 billion as well or the down 8.5% and clearly was the impact from Q2. And also we can see here, the significant impact on our EBIT and adjusted EBIT of what’s happened in Q2, so, EBIT at €360 million, adjusted EBIT from €624 million, down to €406 million. And also here 8.1% margin is clearly not enough for us.
And cash flow at €385 million, Q2 was a solid cash flow, now, slightly lower. Ilkka will talk about more down from the really exceptionally high level of over €900 million last year.
And earnings per share also down from €0.92 to €0.51 per share. It is clear that a lot of things have happened in the quarter in the first half of the year, everything from COVID lockdowns in China, the war in Ukraine, disrupted supply chains, but at the same time, good opportunities in services and North America and many other markets. So, it’s been a very changing environment and that of course, takes a lot from the teams.
And I must say that I think the KONE teams have done an outstanding job again in navigating this environment, finding opportunities, continue to drive improvement as we will talk more about today. So, huge, huge thank you to everyone at KONE for that.
And we can see that employees at KONE are doing a great job and also they remain highly engaged. In the quarter, we again conducted our annual employee engagement survey and we can see that our employee engagement stayed at a good level. It was slightly down year-over-year, but it’s clearly above where it was pre-pandemic level, clearly above, outside benchmarks.
So, overall, in this type of environment, with a lot of uncertainty in the world, overall, we can see that engagement of our employees is high and when we look at the overall survey, feed was actually pretty good. So, that’s I’m incredibly happy about.
We can also see the great work our employees are doing in the development of our Net Promoter Score. So, in the quarter, we did our annual Net Promoter Survey, where we surveyed broadly our customers globally and I’m happy to say that we had another good year of improvement.
And what I’m particularly pleased about here is that we know that supply chains have been disrupted this year and there’s been a lot of uncertainty. At the same time, our customers are giving us constantly better feedback on how we are delivering to them.
So, we had a broad based improvement, both in the services business, in new equipment business, and through most geographic regions. So, really, really a strong result here.
What is the feedback we’re getting from our customers is that they very much appreciate the quality of our products, overall, our products, the quality of our services, how we serve in a relationship with KONE. And clearly we have areas we can improve, for example, in customer communications and how we interact with them.
Many things are moving forward and we can see this trend over many years has been quite positive. So, I think these are two very, very fundamental topics and of course, these are the first two strategic targets are about making KONE a great place to work, and have the most loyal customers. So, therefore, these are really important and fundamental metrics to us. So, that’s something I’m definitely happy about.
So, that’s a little bit of highlights of what’s been going on at KONE in Q1. Then what about the markets? So, when I look at the new equipment markets, we again have two very different stories here. New equipment markets outside of China have actually been good. Clear growth in North America, growth also Europe, Middle East, and Africa, particularly in South Europe, and then good growth in the Middle East. Although we can see some impact of the war in Ukraine on demand in Central and North Europe, and perhaps the energy crisis have a little bit more of an impact there. But overall growing markets.
Also in Asia-Pacific, outside of China, significant growth in Asia-Pacific outside of China. And here really call out for example, India, which we all know is a very important market for KONE, great development in that market.
But then it’s clear that China was significantly impacted by COVID-19 lockdowns and continued liquidity constraints on developers. So, that means the market did decline significantly. But I’ll come back to that a little bit more in detail soon.
Service markets continue to develop very nicely. So, this is really continue to be a good story. Maintenance, some growth in all of the mature markets and clear and good growth in Asia-Pacific.
Perhaps the most positive market overall is the modernization market right now, with significant growth in both North America and Asia-Pacific, and also clear growth in Europe, Middle East, and Africa. So, we’ve been putting a lot of efforts here and I must say that the development also modernization from a product perspective has been excellent. So, a lot of great opportunities there.
And when we look at the fundamentals for the service business, this chart you have seen now throughout the pandemic from us, this is again the monthly average number of starts per elevator from a very broad base of connected units. What is positive is we can see that number of starts per elevator is more or less at pre-pandemic levels. So, people are moving out and about. Yes, it differs a bit by country and by segment, but by and large back there. And why do we follow this? Because this tells us about the longer term need for maintaining and upgrading elevators and we definitely see that the need is there. So, this is a great development, a good picture for us as well.
So, a little bit more about China. If you look at the property markets first of all, as I mentioned, the big impacts have been liquidity constraints for developers and of course, COVID-19 lockdowns. So, the overall markets declined by more than 20% in Q2 and the pricing environment was very intense. There’s no question about that.
So, the lockdowns had a negative impact on many markets and of course, created uncertainty that I think is clear to everyone. However, we have started to see some easing measures, particularly from local governments to stimulate limit the demand side from consumers.
So actually, I’m not sure we call it stimulus, but they have reduced restrictions for buyers. Some — also improvement in liquidity, but not significant yet. What is the situation for KONE? So, in April, there was several weeks when the City of Kunshan was in total lockdown, so it was impossible to keep the factory open. And then when went to May, we had for a while so-called closed loop productions, it was still limited production. Although in June, we were back to full capacity in our supply chains both include Kunshan and Nanxun, both ourselves and our suppliers. So, we did recover pretty well from there.
Maintenance has been resilient, of course, modernization has been impacted by same issues as the supply chain. So, that was clearly the big impact and our sales declined in China as a result of this in total about 40% in this quarter.
But what I already mentioned is a positive thing is that there’s been solid demand for KONE solutions. If we look at the statistics for the real estate market, we can see that there are clearly challenges with real estate investments down. Also residential sales volume in new starts. What is price positive is that prices in 70 larger cities have been very stable. It is also clear that we are starting to see improvement in all these numbers and therefore we’re expecting a somewhat better second half than first half in this perspective.
So, that is about KONE’s development and markets. And now, I’ll hand over to Ilkka to talk more about our financial development.
Ilkka Hara
Thank you, Henrik and also welcome on my behalf to this webcast for second quarter results this year. I’ll go through our financials in more detail and start with orders received development. Orders received for the quarter were €2.609 billion. On a reported basis, a growth of 8.2% and on a comparable basis 0.6% growth in the quarter.
I would say that this robust, considering the environment where we operate, we saw strong growth in Americas, as well as in Europe, Middle East, Africa, and Asia-Pacific excluding China grew strongly in the quarter. Naturally, China’s impact than drew APAC as a whole to decline.
Second, our actions around pricing, product cost aimed at our margins are progressing well. I’ll come back to them a little bit later in my presentation in more detail. But as a result, we continue to see sequentially orders received margin improving again. So, starting from fourth quarter last year, we’ve now seen three quarters of improvement in the margins. At the same time, we’re still slightly down compared to last year’s equivalent quarter in the margin.
Then to sales, sales for the quarter were €2.555 billion, down on a reported basis is 9.1% and on a comparable basis 15.2%. Americas grew its sales by 2%, Europe, Middle East, Africa came down slightly at 1.4%, and APAC overall declined by 31.5%, driven by the development in China where our sales declined close to 40%. In the rest of the Asia-Pacific, we actually saw growth in our sales.
In business line wise, new equipment was impacted by China and declined 30.1%, but we continue to see very strong development in our services business led by the maintenance growing 7.6%. So, very good development there. Also modernization were stable compared to last year at 0.5% down.
Then to adjusted EBIT, which for the quarter was €209 million and the margin was 8.2%. While we did see the good development in services contributing positively to our growth of our adjusted EBIT, the decline in sales in China naturally had a negative impact overall.
From a profitability perspective, we continue to see improved quality as well as productivity contributing positively. At the same time then in second quarter, the impact of increasing input costs was €70 million covering the material component logistics costs. And then naturally from a profitability perspective, having less sales, we had a lower fixed cost absorption as a result.
As already said by Henrik, this is not naturally a level where we’re happy with. And as a result, we have very clear actions on how to improve our financial performance. We’re driving pricing across all regions and businesses and also implementing more dynamic contracts models, which are better suited for this highly volatile cost environment. In pricing, we see a very good progress in maintenance as well as in modernization where we’ve been able to almost fully transfer to price the increased costs.
At the same time in new equipment, our pricing develops positively when we look at Americas, Asia-Pacific, as well as in Europe. And while we still have more work to be done to be able to fully offset the increasing costs, we progressed well. In China, the pricing is — clearly it is more challenging market from that perspective.
Then the second action is around product cost, actions in sourcing and our offering developments decreased the product cost. There, we continue to make good progress and we are seeing two to three times higher product cost reductions that we normally see. And while the pricing environment in China is more challenging, there we’ve been seeing then a better development from a product cost perspective leading clearly, globally the effort there. But also another factor is we see good development from a product cost perspective.
These are the actions that are really about the orders that are coming in the new business. We also have existing orderbook and we’re focused on improving margins there. And clearly, driving productivity across the business is important. We’ve seen now for the first half of the year, good development in productivity, actually better than we’ve seen in the past. So, that’s helping us then to counter some of the headwind that we have for the existing orders going forward.
And last, clearly, we need to and we are accelerating the services business growth. For the first half, we’ve seen very good growth in the services business and maintenance, especially as clearly one of the key actions to drive the improved financial performance going forward.
Then lastly to cash flow. Cash flow for the quarter was €167 million, that’s down from what I would call exceptionally high level in previous year second quarter. Operating income contributing to decrease in cash flow. But also last year, we had a very positive development from working capital point of view. Now, we actually see working capital coming — going up slightly and the key drivers for that are accounts payable. There we had exceptionally high level, I would say, on payables, now it’s more normalized. We have increased inventories, given the environment where we’re operating from a supply chain perspective.
And then lastly, particularly now, in the second quarter, we announced the divestment and suspension of our deliveries in our operations in Russia, having also a negative impact to working capital as we’re ramping down the equipment business there.
But with that, I’ll hand over back to Henrik to cover market and business outlook for the rest of the year.
Henrik Ehrnrooth
Thank you, Ilkka. So, to wrap-up new equipment markets for the full year this year, again, two different stories. Chinese equipment market we expect to decline significantly this year, due to tighter liquidity situation for developers and of course, COVID-19. What this means we think the market is going to down about 50% for the full year, year-on-year.
The rest of the world, we expect that the activity will increase, so good markets overall in rest of the world. Also modernization markets, we expect that they will continue to be — to grow and be very solid. That’s been definitely a positive in this industry. And maintenance markets returning to pre-pandemic growth trajectory, which means slight growth in mature markets and good growth in Asia-Pacific. So, really what we’ve been seeing for a longer period of time.
Then our business outlook, which we announced already last week, we now expect our sales to be in the range from minus 1% to plus 3% in comparable currencies compared to last year. And we expect our adjusted EBIT to be in the range of €1.130 billion to €1.210 billion and that assumes that foreign exchange rates stay about the level where they are now.
Now, as usual, there are a number of things that are positive, driving our performance, the great outlook for our services business, and the performance there, and our very solid and large orderbook.
We also expect that the profit improvement actions that Ilkka talked about, such as productivity, pricing, cost and so forth, will start to have a positive impact towards the latter part of the year.
Then, as we know, there are a bunch of things burdening our result, about €200 million headwind from materials, components, logistics, and so forth. What I would say here is that while headwind continues to be very significant, that we’re starting to see the first signs, I wouldn’t say anything concrete, but first signs of improvement in global supply chains, overall logistics and perhaps component availability and so forth. Still tight, but at least first signs of improvement.
Clearly, also COVID-19 lockdowns have an impact and also the competitive dynamics and pricing in the China market are very challenging.
So, to wrap-up, great continued development in our services business that I’m very, very pleased about. It’s clear that we have very strong focus right now on delivery execution so that we can deliver on our large orderbook, which we’re confident we can do, and secure continued progress in our actions to improve our profitability. We have good momentum there and that we want to continue.
Perhaps the most positive is that we have an high employee engagement that is absolutely fundamental in environment like this. We have an improving customer loyalty. I think these are absolutely great positives in capturing opportunities going forward.
So, with that, we are definitely ready for your questions.
Question-and-Answer Session
Operator
Of course, thank you. [Operator Instructions]
We’ll go ahead and take our first question from Daniela Costa with Goldman Sachs. Please go ahead.
Daniela Costa
Hi, good afternoon. Thank you so much for taking my questions. I’ll stick to one and then I will ask a follow-up afterwards. But I — I mean, looking at your slide on China, it sounds likes despite the market drop, you’re still gaining market share there or at least, I wanted to ask you to — how do you read the fact that you’re seeing — your units are only down 10, the markets down more than 20, is it market share gain from who? Or is it just where you’re distributed in the country or any sort of mixed impacts? But how do you sort of phrase that difference?
Henrik Ehrnrooth
Thank you. I would say that yes, we clearly had a very robust performance compared to the markets. Again, I would highlight again, as we said so many times that this is one quarter, a quarter, there can be fluctuations. But it’s clear that relative to the China market, I think we’re performing well. I do think we are performing well.
We know many of the smaller players are challenged in this type of environment. So, I cannot say really who we take market share from, but clearly we have that — but that’s I’m not sure the most relevant point. But yes, we are performing well. We are doing well. But again, let’s remember it’s one quarter, but also if we look at the first half year, performance has been pretty solid from that perspective.
Daniela Costa
And then, my follow-up relates to Europe and U.S. equipment margins, given what you have said in past calls regarding your profitability on service not being too different from where one of your peers that discloses it is and where — what you’ve said in the past regarding China, I don’t know if this is still true, but China not being below group margin at the moment. I’m not sure if this was true, but that looks like your Europe and U.S. equipment margins must be very, very low or even breakeven. Can you talk about sort of, I know you don’t comment on levels, but compared to history, where we are there? And how much potential raw material tailwind going into 2023 helps you normalize that to historical level?
Henrik Ehrnrooth
Yes, maybe Ilkka, you start with that.
Ilkka Hara
Yes. So, I would say that, clearly, second quarter, from equipment business perspective was heavily impacted by first, the COVID-related measures in China and volumes were lower than normally. And also the cost levels have increased considerably as we’ve said about the input cost and that’s mainly then impacting our new equipment business as such.
In — and your question around, then new equipment business outside of China, the profitability there, clearly it is something where the input costs have impacted the profitability negatively and we’re on an annualized basis, profitable in new equipment, but short-term in Q2, but that is impacted by these headwinds.
Operator
And we’ll go ahead and move on to our next question from Jeff Sprague with Vertical Research. Please go ahead.
Jeff Sprague
Good morning. Good day, everyone. Thanks for the question. I’m just wondering if on China, you could unpack that a little bit further. Obviously, your revenues down 40%, and your new equipment units down 10%, well, the implication, as you noted is price is quite weak. But can you provide a little bit of color on a bridge between those two items, price versus maybe mix or the mix erosion going on in China also? Thank you.
Ilkka Hara
I can take it.
Henrik Ehrnrooth
You can take, yes.
Ilkka Hara
Yes. So, in China, in the quarter both mix as well as price contributed slightly negatively to — due to our orders. It’s not a big change and pricing is more driven — sorry, mix is more driven by somewhat lower floors and as a result, slight mix — negative mix impact.
Henrik Ehrnrooth
But — and you mentioned first to 40%, that’s revenues, that’s deliveries, and then 10% this orders, two totally different numbers. So, that, of course, is just want to highlight.
Jeff Sprague
Right. Thanks for that. And just as a follow-up just on the guidance, obviously, you indicated that some of the actions might be a bit more backend loaded, the productivity and other actions. But can you give us some sense of how you see the remaining trajectory of the year playing out? How much improvement you do expected in Q3, or is this really very Q4-weighted to reach your guidance? Thank you.
Ilkka Hara
Well, I guess we are not guiding on a quarterly basis, but if you think about the nature of the actions, clearly, we’ve seen now prices and sorry, margins for orders received starting to improve latter part of last year, some of those start to be in delivery at the latter part of the year, so, gradually contributing positively.
Also the product cost actions that we’ve talked about, they will gradually start to then impact also our manufacturing and be — then impact in P&L. So, gradually, I expect that the margins will then recover towards the latter part of the year. But we will start to see some of that slowly impacting then also Q3.
Henrik Ehrnrooth
Of course, the big difference in Q2 is that we’re not expecting this type of lockdowns that we had that we can have a good deliveries, we have a great orderbook, we have a good service business. So, all of those things are in place for us.
Operator
We will go ahead and move on to our next question from Andre Kukhnin with Credit Suisse. Please go ahead.
Andre Kukhnin
Good afternoon, and thanks for taking my question and follow-up. My question is on China impact if you could help us quantify the EBIT impact from that 40% decline? And maybe around that 40% I guess there’s a combination of what would be the underlying decline that already started from orders to revenue in Q1? Is there any chance to also get a gauge on how much the lockdowns added on top of that, if that’s at all possible? And then I’ll have a follow-up.
Ilkka Hara
Well, normally, there’s a sequential of increase in revenues from Q1 to Q2 related to normal seasonality. And in Q2, as you said, we saw our revenue from last year decreased by 40%. So, we’re talking about in order of magnitude, €400 million to €500 million impact into our revenue.
And then as a result, over €100 million cost or EBIT the impact. There’s both the drop-through, but also in this environment, naturally, operating is more expensive as well. There’s not one-off cost, but costs related to operating in this environment.
Andre Kukhnin
Right. Thank you. And is there an element of catch-up of this baked into your guidance for the full year? And could you give us some idea of maybe how much of that catch-up you expect maybe at the midpoint of the guidance range please?
Ilkka Hara
There is some catch-up expected there. I don’t think we’re going to define it more in detail, but there’s some custom catch-up clearly.
Henrik Ehrnrooth
Clearly you can see Andre that we have a very big orderbook. So, at least we have plenty to deliver, which is very positive.
Operator
And we’ll go ahead and move on to our next question from Miguel Borrega with BNP Paribas. Please.
Miguel Borrega
Hello, everyone. Thanks for taking my questions. On the margins of orders being done year-on-year, but sequentially up, can you just be a little bit more clear on what that really means? Because if you were aiming for margin of let’s say, for the sake of the argument, 5% last year, when you were doing 4%, it’s quite different from now that you’re maybe targeting 4% between 1%? Is that the right way to think about this? Or can you give us a better picture of what sequentially better margins mean?
Ilkka Hara
So, we’re slightly improving sequentially. I don’t think we’re going to quantify that that much more. Clearly, our ambition is to be able to improve and return to levels of margins that we’ve seen in the past. So, those actions are ongoing and this is just the way to report the progress compared to last year and previous quarter.
Miguel Borrega
Okay. And then on your order intake, how are things changing in the sense of offsetting cost inflation, can you give us a sense of how many of these dynamic contract models have been already implemented out of Q2 orders? Will we see kind of the new way of working going forward or still quite limited to certain regions and clients?
Henrik Ehrnrooth
So, I would say it varies, I would say, Ilkka mentioned in his presentation, perhaps, when it comes to pricing and offsetting costs, best in the services business, both maintenance and modernization, actually monetization doing very well there. New equipment business, still some way to go, but the momentum is right here, perhaps best in North America, then both Europe and Asia-Pacific, perhaps Asia-Pacific has — had the best momentum right now, so — outside of China. So, many, many good development there.
When we think about this more dynamic contract models, so of course, they have existed in some parts of the business, but that hasn’t been a very high percentage on and that, of course, then helps a bit. But it’s clear that we started impact the implement that now through tenders before those are done in orders and deliveries. So, of course, it’s not going to turn very quickly. But it’s a longer term initiative that we think it’s important to get a closer correlation between costs and orderbook. But I would say that we went and getting — started to implement that in the business I think actually is going pretty well.
Operator
And we’ll move on to our next question from Klas Bergelind with Citi. Please go ahead.
Klas Bergelind
Thank you. Hi, Henrik an Ilkka [indiscernible]. So, the first one is on your freight cost, I don’t think you pass this on automatically as part of your contract. So, when these costs start to go down and you alluded Henrik that you’re starting to see the first signs of an improvement to supply chains. This should obviously be positive. And I also remember correctly that I think that your renegotiate the contractual part at mid-year, which is right now. I’m trying to get your timing, but also how much you’re buying a spot versus contract? I’ll stop there.
Ilkka Hara
Maybe I’ll start and then you can comment. And I think I’m not sure I heard you correctly, you’re talking about logistics, I guess in the beginning. Ongoingly contract with our logistics suppliers as with our other suppliers as well. And I would say that, from a input cost, logistics cost perspective, we have a pretty good visibility for the year 2022 already. So, we’re committed and also start to be — have a quite a clearer picture on the mix, which countries and so forth. So, there overall, the cost headwind now is the €200 million and there’s less variability there.
In logistics, I think what has been in the past the challenge is that you have a base price, but then you need to add capacity with spot purchases on logistics. And those spot purchases have been very expensive. And I think here, we’re now starting to see not only the availability be there, but also then having to use less of the spot purchases and overall logistics costs, especially sea freight starts to come down. But I don’t think we’re going to see much of that as impact anymore this year.
Then the separate story is that in road transportation, naturally, that is then the next challenge, there the prices continue to be on a quite high level and also capacity quite tight.
Klas Bergelind
Yes. No, I’m trying to gauge the impact with 2023. I appreciate 2022 is too early to see it. But anything there on contracts versus spots if you have that split, I don’t have it right now.
Ilkka Hara
No, I think the spot normally has not been used during the last years. It is something where we’ve had to supplement then the capacity where there’s — hasn’t been enough. I think normally I don’t expect that we would start to use more of that spot purchases for logistics in larger scale.
Henrik Ehrnrooth
That’s when — many of the trade lanes have been overly full. You have had no flexibility. If you have a little bit less at some point, then you haven’t — it’s not really been able to move that capacity later, which is usually the possibility. So, I think it’s just a more stable and more environment. You can plan better right now.
Klas Bergelind
Yes. No, that makes sense. My follow-up is on the team side, we’re seeing some quite big drops here. And sometimes you give us an indication of what you think the impact will be beyond this year at current spot. I don’t know if you are willing to do that. But I’ll give it a try.
Ilkka Hara
Sorry, can you repeat the question? I didn’t hear–
Henrik Ehrnrooth
Sorry, bad line here.
Klas Bergelind
I’m sorry. On the steel side, we’ve seen quite big drops. And sometimes, Ilkka you are helpful with the impact beyond this year at current spot. I don’t know if you’re willing to go that far. If you could hear me. Sorry.
Ilkka Hara
Yes, now we’re hear. Thanks and sorry for that. So, let’s see, steel in China has come down and — whereas I would say that’s been outside of China then continues to be at a quite a high level. So, let’s see when we get a bit closer to 2023. If the development would be similar to what we’ve seen now that would start meaning that there could be some positive, but it’s too early to comment that yet.
Henrik Ehrnrooth
I think the only thing we can say — only thing we know is that the volatility is likely to be high going forward, which direction that we would then see.
Operator
And we’ll go ahead and take our next question from Alexander Virgo with Bank of America. Please go ahead.
Alexander Virgo
Thanks very much. Good afternoon gentlemen. Thanks for taking my question. So, the first question I wanted to just touch on was the dynamics that you saw in Q1 with respect to your decisions around to whom you were delivering in China and the liquidity concerns, the quality of the customer base?
I guess it’s pretty difficult to disaggregate that in Q2 because of the lockdowns, but it doesn’t — I didn’t get the impression that that has improved an awful lot. So, I’m just trying to get a sense of why you feel there can be a reasonable amount of recovery in in the second half? So, that’s the first question just a little bit of a conversation around the quality of the customer base.
And the follow-up would be related to that, I guess you’ve seen quite a big build in working capital, partly as a function of decisions you’re making yourself and also, the fact that the problems of lockdown, I’m just wondering how we would — you would expect to see that working capital unwind through the back half of the year, so we can get a sense of cash generation? Thank you.
Ilkka Hara
Well, if I start, first on the quality of customer, so I would say that in Q2, clearly, the bigger challenge was the capability to deliver. And yes, we continue to be managing our payment terms and customer risk quite tightly, as we talked about in Q2 — a conjunction of Q1 results, but clearly, in Q2, the impact was larger due to the lockdown measures. And going forward, naturally, we’ll continue managing that risk quite tightly.
Then, from a cash flow perspective, I think it’s good to remember that when we talk about working capital change, so last year, Q2, we had a very, very good improvement in working capital.
Now, it was the opposite direction about the same change around €85 million. And out of that €85 million, roughly €50 million actually was related to the decision we made on our business in Russia, where we’re unwinding the business. So, I would not over-emphasize the working capital change, because at the end of the day on — if you look at the big picture, it hasn’t changed much.
And naturally, when we grow, it helps us. When it comes to advances, especially in the equipment business and vice versa, if we see a decrease in orders, then that would have opposite impact.
Operator
And we’ll go ahead and move on to our next question from Andrew Wilson with JPMorgan. Please go ahead.
Andrew Wilson
Hi. Good afternoon. Thanks for taking my question. I think it’s a bit of a follow-on from Alex’s question previously, actually. I’m just trying to get a sense of — I think when we’ve talked before about the expectations on the second half in China, it’s been — we expected, I guess, the market conditions to improve. And obviously, I guess I’m interested in updating how you’re thinking about that.
Now, clearly, it’s going to improve on Q2, which is very heavily impacted by lockdowns. But when you think about what the government has or hasn’t done with regards to policy, and how that’s, I guess, impact activity on the ground. Can you give us a sense of sort of, if what you’ve seen from a policy perspective, and I guess from the customer indications perspective that you’re as confident around that recovery as you were previously? Pretty sure that’s quite a general question, but just really trying to get a sense on your confidence around that improving at least order number, I think probably for China.
Henrik Ehrnrooth
I would put it that this way that we are not expecting any massive changes in the environment and government actions. We expect the market will continue to be as it is right, which has challenged, but they still have a big orderbook to deliver the developers and they will — they need to deliver that and that liquidity will continue to be quite tight.
So, we’re not counting on anything very significant that would happen in the market. If something significant would happen to the positive side, it would then more probably impact orders rather than deliveries.
But at the same time, we’re also not expecting any significant lockdowns that we saw in Q2, that of course, there are smaller lockdowns here or there, but I think they’re quite manageable.
Andrew Wilson
Thank you. And just as a follow-up and I appreciate, it’s a slightly different area, but maybe just looking for a little bit of help on some of the margin drivers. Kind of talk a couple of times around the — and product costs and some of the actions around productivity.
I don’t know if you could help us try and quantify some of the potential benefits. I appreciate it’s often difficult to isolate these, but just to guess give us a bit more confidence in terms of the help on the margin for the second half versus — and I guess into 2023 as well please?
Ilkka Hara
Well, I guess on a product cost side, normally when we look at product cost actions that we take, we’ve seen maybe 2% or 3% decrease on an annual basis on product cost. As I said now we’ve been able to see two to three times that, maybe that’s the one way to think about the magnitude of those actions.
I think the actions that we have now in place and expect to be in place for the second half are quite clearly — we have a good line of sight to those actions. And then normally, it always takes a bit of time to then implement that to the new production and then start to see those elevators are approved with a lower product cost then being delivered and then recognized on the P&L. So, that’s more the timing difference then towards the latter part of the year.
Operator
Next question comes from Guillermo Peigneux with UBS. Please go ahead.
Guillermo Peigneux-Lojo
Thank you. I guess that was Guillermo Peigneux from UBS. Maybe a follow-up question from previous questions on steel prices, especially when you look at steel prices in China, we’ve seen spot basically going down in some instances by a third. And rather than asking the magnitude, can we ask when would you start to see it in your P&L? i.e. basically when would you start to filter through these lower cost levels in your Chinese installations if I may? And I have a follow-up.
Ilkka Hara
Well, if the prices were, as you said, then we would start to see the benefit in first half of next year. There’s always a timing difference, as you saw in 2021, when the prices weren’t going up, we were mostly not impacted in the first half start to really then impact in third quarter and the fourth quarter. So, there’s a three to six months’ lag normally.
This year, we already have quite a good visibility. We’re quite — our prices are locked with our suppliers and also with the inventory rotation. So, I would not expect the a big changes anymore into this year’s results, but sometime then early next year.
Guillermo Peigneux-Lojo
Thank you. And my follow-up is, I worry a bit about pricing. Now, that obviously [indiscernible] will be very interesting activity and then liquidation will be taken up towards. As you said the fundamentals are engraved. And with [indiscernible] going down, what do you think pricing will do next year? I know, it’s a bit early to ask, but would you say that is — there is a chance that actually we will assume pricing pressures to the magnitude that people will likely gain market share in a flat market, or in a potentially weak market? Thank you.
Henrik Ehrnrooth
I think we need to put it in perspective as well, that there’s still waiting to do to catch up with prices have gone up and I think that everyone in the industry are feeling it. So, clearly — and then when you look at China, where costs are then coming more down, you have not seen price increases there. So, from that perspective, I would not be so worried about that.
I trust that everyone understands that, hey, there is a need to improve margins throughout the industry and therefore, driving a better margin and that’s what we are very focused on right now. And we have to also have to see, but — and it’s also a big difference. If you look at Europe, here actually steel price others continue to be at the very high level, U.S. perhaps slightly down, but also at a high level. And I guess it has — in Europe, it has a lot to do with the energy crisis that we are facing here right now.
Operator
We’ll go ahead and move on to our next question from Martin Flueckiger with Kepler. Please go ahead.
Martin Flueckiger
Yes, afternoon gentlemen. Thanks for taking my question. Again, on China, I’m afraid we’ve been reading about these revolt by apartment or housing buyers in China. And quite literally the images and the videos that we were able to see were bit frightening to about what’s going to happen here.
Now, I’ve seen what the regulators are suggesting to the banks, but I was just wondering what kind of feedback was that you’ve got — that you received from your team in China, how they view the situation and what they make out of this going forward, whether the downward spiral will be broken or whether there’s further downside risks from here? And I have a follow-up after that.
Henrik Ehrnrooth
Okay. So, clear that has been locked in the press over the past days. Of course, if consumers have made a down payment, are paying mortgage already and not getting delivery of their apartment, clearly that’s a concern. And we are seeing that government is taking action to make sure that the developers are speeding up so that they can deliver this.
And that should have somewhat positive impact for us if deliveries are actually speed up because of this, so we can complete installations and hopefully, slightly better liquidity for them.
But clearly this is a topic they need to take seriously. And I think they are taking seriously. So, we have to see how it develops. But as I said, it seems that the government is stepping in here quite clearly to protect the consumers.
Martin Flueckiger
Okay. and then my follow-up is just a clarification question really to Ilkka. Did I understand you correctly that the China impact on adjusted EBIT in Q2 was €100 million as you mentioned two numbers that I wasn’t sure which one was which?
Ilkka Hara
Yes, I said, over €100 million in Q2 results.
Operator
And we’ll go ahead and move on to our next question from — comes from [indiscernible]. Please.
Unidentified Analyst
Yes. Hi. Henrik and Ilkka. I have two questions. First, I wonder about the margin on orders received. Now, if you compare that to Q3 last year, are we still down year-on-year? I mean, that was when you had the big drop. Are we now on par with the leveling Q3 last year?
Henrik Ehrnrooth
We are up from last year’s Q3. So, up in Q4, Q2, Q1, and now in Q2 as well. So, that is up.
Unidentified Analyst
Okay. And then you have always said that, this industry doesn’t really have any fixed capacity or the industry does not pay up a lot of costs. And still you have seen these kind of big margin collapse throughout the industry almost, it seems. And it’s kind of hard to believe that companies would not really know what’s going on, because some pricing I mean, many other industries are doing very well with their margin. So, from a life worth philosophical, kind of, point of view, what do you think is kind of, really the problem is it’s only the China exposure, but it seems to have problems in margin liquidity also in other western markets in a different fashion than you see in other window [ph], and that’s kind of — just kind of hard to understand why it would be more difficult in this industry than many other engineering industries at the moment?
Henrik Ehrnrooth
So, I would put it in two different buckets. If you look at the services business, actually, there prices are up to cover costs and in some cases, even more than that. Of course, it takes a bit of time for modernization to come through the orderbook, but it’s much faster moving.
In new equipment, it’s a business that is very much driven by tenders, very competitive there. And then of course, the challenge is that you have the wrong orderbook. So, before you have tender prices up before orders are there, it takes a good time for it to come through. But clearly there price development has been slower than for example, in the services business. And it’s just the commercial dynamics are different, but it’s kind of two very different stories. If you look at services and new equipment, obviously, new equipment, we are clearly up in prices outside of China, so far this year. So, we’re definitely going in the right direction. And I think in most markets, we’ll get there. I’m very confident with that. It just takes little bit of time.
Operator
And our next question comes from Daniela Costa with Goldman Sachs. Please go ahead.
Daniela Costa
Thank you for taking my follow-up. Just wanted to ask back on China, obviously, on the backlog, which, I guess is a sizable portion of your overall backlog, but we’re seeing a lot of uncertainty, I guess around what happens in a local market. Can you recall us like how long do you keep things in the backlog until you have to maybe write them off? I think you did this in the prior crisis once, I know we’re not there yet. But just to have an idea on how should we think about length of the backlog and delivery? Thank you.
Ilkka Hara
Well, I guess, overall, our fastest circulating orderbook in the new equipment business is in China, approximately nine months in terms of circulation. And so that’s the overall picture.
Then we assess the quality of the orderbook continuously every quarter. And as a result, then cancel orders in case they’re not likely to be delivered. Amount of cancellations have remained to be low and I think in this quarter, particularly we actually canceled on ourselves that Russia related orders which took that up a bit. But in China, it has continued to be on a low level.
And to be honest, if we look at the past, it’s still the cancellations, I mean, there were some in the 2016, 2017, when the prices came down quite dramatically, but otherwise, it’s been more stable and the cancellations from customers have been actually quite a low level.
Daniela Costa
And the rotation at the moment is still within those nine months, it hasn’t expanded from order to delivery?
Ilkka Hara
The order circulation has been as a result, I mean, we didn’t deliver as many orders as we expected. So, it is slightly up as a result, but I would say that, still the nine months is a good way to think about it.
Daniela Costa
Okay. Thank you very much.
Henrik Ehrnrooth
Thank you.
Operator
And we’ll go ahead and take our last question from Andre Kukhnin with Credit Suisse. Please go ahead.
Andre Kukhnin
Hi, again, thanks so much for taking the further follow-up questions. I wanted to come back first to those mitigating measures and just to get the confirmation of sizes. I think at your Capital Markets Day you said that together pricing and cost out measures should mitigate about half of the cumulative raw materials and logistics headwind, which are adding up to €400 million now across 2021 and 2022.
So, is it right to think that you’ve got that kind of €200 million annualized tailwind coming in and gradually from Q3 this year into Q4 and then building up to the full run rate by in the first half of 2023, without the right cadence and right magnitude?
Ilkka Hara
Well, I guess what we said, there was it also status check where we are. And now with actions continuing to progress positively, we’re a bit better than that. But — and the comment was, especially about the new equipment business. Then in the maintenance and modernization, as we said, we are actually progressing much faster than that and almost there when it comes to countering the cost headwind, when it comes to the modernization business and that’s naturally then a bit faster circulating.
On the new equipment side, it will take some time for those orders that we’ve continuously book now with improving margins, then to come to delivery. And in China, as I said, the orderbook rotation is around nine months, and then you look at Europe being over a year, and North America, then clearly over a year. So, clearly, that’s then how it will be visible in the P&L when it comes to the pricing part.
On the product cost side, we’ll gradually start to see more and more of that coming through in latter part of this year. And probably during the first half, then in full extent. But as always, we’re not stopping to improve our product costs. So, hopefully see, then continuous good progress there on next year as well.
Henrik Ehrnrooth
And I think Andre, I think matches sounds clear, but it’s perhaps not quite that straightforward, because €200 million this year, that includes already some of the benefits from the improvement actions. So, yes, of course, our target is to come back to the levels we were while ago, we still have some way to go there. But it’s not quite that you can say €200 million immediately improvement in a short-term, because some of that improvement is already baked into that €200 million. But of course, a lot of actions continue and I must say I’m quite positive, how our pricing outside of China is developing right now. Momentum is definitely there.
Andre Kukhnin
Got it. Okay. So, €200 million this year would have been high, you hadn’t taken some of these measures, so we shouldn’t double count.
Henrik Ehrnrooth
Indeed.
Andre Kukhnin
And on the ambition — thank you. And on ambition of getting that order intake or order backlog margin up to where it was historically, say 2020 levels. How far below are we at the moment? Is there any way to tell?
Ilkka Hara
Well, I think first what we’ve commented is the orders that we book those margins and in orderbook, there’s always a mix impacts when it comes to businesses and geographies. So, it’s not as good proxy for the future. But clearly our ambition that we’ve commented was on the orders booked.
Henrik Ehrnrooth
And if you think if you book orders, for example, last quarter this year not necessarily — it’s not going to necessarily show up in the following year, some will, but not all. So, there’s going to be a gradual improvement. I think the important thing is that pricing is definitely taking us in the right direction and from services, we’re seeing the faster impact then from new equipment.
Andre Kukhnin
Right, I’m sorry, very quick. Last one, I know we’re an hour. The — just looking at Q2 performance and what you said about China being down 40%, that still in place down a couple of percent for kind of the rest, to get to the 15.2% overall, and in the rest, we’ve got service up. So, I just wanted to check if a new equipment there was softness elsewhere in the second quarter that we should be aware of and find out whether that’s run rate or any one-off effect?
Ilkka Hara
Well, I guess, sales in Europe, Middle East, Africa were down in the quarter. And there we are seeing that some of the customers, especially in the new equipment side are having difficulties and taking their project forward as they planned. It’s about having the supply chain, access to labor, and so on, that are impacting the project. So, slight delays from that respect impacting the revenue in the quarter.
North America as well as some impact of especially labor, I guess they’re being tight. But as I said, we saw growth in the sales in U.S., so slightly less, while the mix is less new equipment heavy, so less impact from there. So, in essence, we do see some slowness in the construction site.
Operator
And with that, that does conclude our question-and-answer session for today. I would now like to hand the call back over to Natalia for any additional or closing remarks.
Natalia Valtasaari
Thank you. And thank you Henrik and Ilkka for the presentation today. Thanks to everyone online for joining in and for the active questions. If you do have any follow-ups, please do feel free to reach out to me and the team. If not, I would like to wish you all a very happy summer.
Henrik Ehrnrooth
Thank you, everyone.
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