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Welcome, and thank you for standing by. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this time. May I introduce your speaker for today, Lloyd Midwinter. Please go ahead.
Hello, and welcome to the AkzoNobel Investor Update for Q3 2018. I'm Lloyd Midwinter, Director, Investor Relations. Today, our CEO, Thierry Vanlancker; and CFO, Maarten de Vries, will guide you through our latest results. We will refer to a presentation, which you can follow on screen and download from our website, akzonobel.com. A replay of this call will also be made available. There will be an opportunity to ask questions after the presentation. For additional information, please contact Investor Relations. Before we start, I would like to remind you about the disclaimer at the back of this presentation. Please note, this is also applicable to the conference call, including answers to your questions. I now hand over to Thierry, who will start on Slide 2 of the presentation.
Thank you, Lloyd, and good morning, everyone. Thank you, as always, for joining the call. During the third quarter of this year, we made further and firm progress towards becoming a focused high-performing Paints and Coatings company. Profitability increased for both Paints and Coatings as a result of our pricing initiatives and cost-saving programs despite challenging market conditions, including high raw material costs and adverse foreign currencies. Our price/mix was 6% higher while volumes were lower. The lower volumes, partly driven by our intended strategy to move away from lower margins given our volume -- value over volume strategy.We delivered EUR 35 million cost savings during the third quarter from Phase 1 of creating a fit-for-purpose organization, and we are now taking the next step in our transformation to deliver the next EUR 200 million cost savings by 2020. Completing the sale of our Specialty Chemicals business was a key milestone for the AkzoNobel company, and we have continued to build on our leading positions in the Paints and Coatings market with the acquisition of Xylazel in Spain, which strengthens our position as the leader in the Spanish Decorative Paints market. And we have also completed the Fabryo acquisition, thereby achieving the #1 position in Romania as well as expanding our Dulux Decorator Centre network in the U.K. Slide 3 shows some of our key highlights for the third quarter 2018. Price and mix was up 6% as a result of our pricing initiatives, one of the major factors contributing to higher return on sales for both the paints businesses and the coatings businesses. Excluding allocated corporate center costs, return on sales increased to 12.3% compared to 10% last year. We have also made continued progress on implementing our Integrated Business Planning, also known as IBP. All coatings businesses have now started the monthly IBP cycles, and the paints businesses are currently undergoing the training to be ready before the end of this year. Having a successful Integrated Business Planning will be a key enabler for future performance improvement. Again, we achieved more than EUR 30 million savings during the quarter from our ALPS continuous improvement program, which continues to successfully offset fixed cost inflation. In addition, we delivered a further EUR 35 million cost saving from Phase 1 of creating a fit-for-purpose organization. So we are exactly on track to achieve the promised EUR 110 million cost savings for 2018. I'll provide more details about the next step in our transformation on the following slide. Our focus on value over volume, despite challenging market conditions, demonstrates how we are creating a high-performance culture. Sustainability has been and will remain one of our core principles. It is part of how we do the business. We were again recognized as a leader in sustainability by being ranked the fourth in the Dow Jones Sustainability Index. This is the 13th year in a row that we have been ranked in the top 10 for our sector. So all in all, I'm very encouraged by what we have so far achieved as we continue to deliver towards our "Winning together - 15 by 20" strategy. We are now taking the next step in our transformation, as summarized on Slide 4. Our plans will deliver the next EUR 200 million annual cost saving by 2020, contributing towards achieving our target of 15% return on sales, excluding unallocated corporate costs. Almost half the savings will come from Integrated Supply Chain, while the rest will be achieved in SG&A and R&D functions. Cost savings will be achieved throughout 2019 and 2020, resulting in an estimated run rate savings of around EUR 240 million in 2021. The one-off costs associated with this next step are expected to be about EUR 350 million and will be incurred between now and 2020 with around 1/3 before the end of 2018. Some of the one-off costs are related to asset network optimization, and around EUR 60 million of this will be noncash items. As a focused Paints and Coatings company, there are many opportunities to work closer together as we step -- take the next step in our transformation delivering towards our "Winning together - 15 by 20" strategy. On Slide 5, I will run through some of the key trends we are seeing in the markets where we operate. As expected, higher raw material costs continued to impact us in the third quarter of 2018. Raw material inflation is projected to continue for the remainder of 2018, although at a slower rate than during the start of the year. Our robust pricing initiatives as well as our cost-saving programs are in place to compensate for higher raw material costs. This remains a key focus for us during the remainder of 2018 and as we look towards 2019.Demand trends clearly differ per region and per segment, as usual. On the one hand, Powder Coatings continued the positive trend while market conditions for Marine and Protective Coatings are still challenging, although these headwinds are reducing versus last year. In China, as we discussed in the second quarter, our value over volume strategy has resulted in lower revenue, especially when compared with the rapid growth in recent years, while we continued to grow in countries like India and Vietnam.Foreign exchange rates continued to represent a significant headwind due to several emerging market currencies, including the Argentinian peso, Brazilian real and the Turkish lira, which, for example, devaluate by up to 15% versus the third quarter of last year. The challenging market conditions will likely remain the case for the rest of 2018, and we are focused on dealing with those headwinds. Slide 6 summarizes some of the financial headlights -- highlights for the quarter. Quarter 3 revenue was flat in constant currencies and price and mix was up 6%, with price realization gaining momentum. Our volumes were lower, partly due to our focus on value over volume. Roughly half of the volume decline was due to us consciously moving away from lower margins, for example, economy lines of paint in China, some opportunistic resin sales in Latin America and nonvalue-adding tenders for Marine Coatings. The remaining volume decline was due to specific market dynamics, including challenges in emerging markets and for Marine and Protective Coatings as well as other temporary impacts in supply chain, for example, changes of our distribution channels around the world. Return on sales was 230 basis points higher at 12.3%, excluding unallocated corporate center costs and up for both Paints and Coatings. I'm very encouraged by what we achieved and the path that we now see to 15 by 20, even if we do not expect a straight line improvement of ROS to 15%, especially considering the smallest seasonal quarters of Q4 and Q1 ahead of us.During the quarter, we also announced the acquisition of Xylazel in Spain. On October 1, we completed the sale of our Specialty Chemicals business as well as the acquisition of Fabryo in Romania. The quarterly trends for volume and price/mix are shown on Slide 7. Here, you see that the price/mix was 6% higher overall for the third quarter as a result of our pricing initiatives. Selling prices increased further, resulting in price/mix up 5% for paints and 7% for coatings. Here, you also see clearly that on the other hand, the volumes were 6% lower overall, as I said, partly driven by moving away from lower margin given our value over volume strategy, as we already indicated the previous quarter. As mentioned, roughly half of the volume decline was due to us consciously and strategically moving away from lower margins. This was especially the case for Decorative Paints in China and Latin America. We also walked away from some nonvalue-adding business, for example, some of those tenders in Marine and Protective Coatings. I now hand over to Maarten, who will run through the financial results in more details on Slide 8 onwards.
Yes. Thank you, Thierry, and hello to everybody on the call. As mentioned earlier, our pricing initiatives are ramping up and price/mix was 6% higher overall. Revenue was flat in constant currencies. Volumes were lower, partly due to our focus on value over volume. Return on sales, excluding unallocated corporate center costs, consistent with the calculation of our 2020 targets, was 12.3% versus 10% last year. Our pricing initiatives and cost-saving programs are dealing with market headwinds. However, we are not expecting our path to achieve 15% to be a straight line. Other activities, also known as unallocated corporate center costs, were EUR 42 million in the third quarter of 2018, nearer the current average quarterly run rate. Last year, this line item was favorably impacted by one-off items as well as lower pension and insurance-related cost of around $20 million. Adjusted operating income increased despite EUR 10 million adverse impact from foreign currencies. Operating income was also up, including EUR 6 million adverse impact from identified items mainly related to the transformation, which now finalizes to EUR 120 million one-off costs associated with Phase 1 of creating a fit-for-purpose organization, which we have announced in October last year. Turning now to Slide 9. Raw material inflation was higher than previously expected at more than EUR 100 million during the third quarter. Higher selling prices in both Paints and Coatings led to a positive price/mix impact of EUR 140 million for the third quarter. Lower volumes partly resulted from our value over volume strategy impacted adjusted operating income by EUR 65 million.Our ALPS continuous improvement program achieved more than EUR 30 million savings during the quarter, successfully offsetting fixed cost inflation. And Phase 1 of creating a fit-for-purpose organization delivered EUR 35 million cost savings during the third quarter. Price increases and cost savings were able to compensate for higher raw material costs during the quarter. We remain focused on dealing with the market challenges and delivering towards our "Winning together - 15 by 20" strategy. Adjusted operating income was also adversely impacted by EUR 10 million adverse foreign currencies, primarily due to the translation impact of several emerging market currencies, including the Argentinian peso, Brazilian real and Turkish lira.Moving now to Slide 10, the financial results for Decorative Paints. Price/mix was 5% higher versus 4% in the second quarter with price realization gaining momentum. Volumes were lower in all regions, mainly due to continued focus on pricing initiatives. Revenue was flat in current -- constant currencies. Exchange rates adversely impacted revenue of Decorative Paints by 6%, due to the devaluation of the Argentinian peso, Brazilian real and the Turkish lira. Return on sales was up 12.1% versus 9.4% last year. Adjusted operating income increased 21% with improved pricing and cost savings more than offsetting higher raw material costs, currency effects and lower volumes. This shows our value over volume strategy is working. Operating income was adversely impacted by EUR 3 million identified items related to the transformation. Now turning to Performance Coatings on Slide 11. Our pricing initiatives in Performance Coatings continued to gain traction, resulting in 7% positive price/mix compared to 5% last quarter with further increases planned. Volumes were lower, mainly for Marine and Protective Coatings. In some cases, we've walked away from nonvalue-added business. Other coatings continued the positive trend with growth of 9% in constant currencies. Revenue for Performance Coatings was overall flat in constant currencies. Adjusted operating income increased 16% as a result of the pricing initiatives, the positive impact of asset network optimization and cost control more than offset adverse currencies, higher raw material costs and lower volumes. Return on sales was up at 12.2% compared to 10.3% in the third quarter of 2017 and up for all businesses. Operating income was negatively impacted by $6 million identified items related to the transformation.Over to Slide 12, which shows the results for Specialty Chemicals, reported as discontinued operations. Revenue was up 6% in constant currencies, driven by 10% higher selling prices as raw material price increases are being passed through. Adjusted operating income was lower, mainly due to adjustments to environmental provisions and other one-off items totaling EUR 35 million. The sale of Specialty Chemicals was completed on October 1, 2018.Now turning to Slide 13. During the third quarter, total net income, and that's for continuing and discontinued operations, increased as a result of higher operating income and lower net financing expenses as well as higher profit from discontinued operations. Earnings per share was EUR 1.18 versus EUR 0.86 last year. Adjusted earnings per share excludes the impact of identified items. Moving to Slide 14. Free cash flow for Paints and Coatings increased for the third quarter due to higher profit and lower capital expenditures, despite higher operating working capital. Operating working capital increased mainly due to higher trade receivables, which have reduced during the quarter, and increased inventories driven by higher raw material costs. At the end of the third quarter, net debt was EUR 2.7 billion versus EUR 1.7 billion last year. Net debt includes the EUR 1 billion special cash dividend, which was paid in December 2017 as advanced proceeds for the separation of Specialty Chemicals. The sale of Specialty Chemicals was completed on October 1. A time line of recent and upcoming events is shown on Slide 15. AkzoNobel announced in April 2017 the plan to separate Specialty Chemicals within 12 months. Advance proceeds were paid as a special dividend of EUR 1 billion in December 2017. And in March 2018, the sale of Specialty Chemicals was announced. Earlier this month, we announced shareholders will receive a further EUR 5.5 billion following completion of the sale of Specialty Chemicals business. The additional EUR 5.5 billion proceeds will be distributed using a capital repayment and share consolidation of EUR 2 billion, special cash dividend of EUR 1 billion and share buyback of EUR 2.5 billion. The capital repayment of share consolidation will be subject to shareholder approval at an extraordinary General Meeting to be held on November 13 this year. This means a total of EUR 6.5 billion will have been distributed to shareholders, delivering on a commitment to return the vast majority of the EUR 7.5 billion net proceeds from the separation of the Specialty Chemicals business. Now turning to Slide 16. The ordinary dividend relevant for AkzoNobel as a focused Paints and Coatings company is EUR 1.65 per share, as announced on April 19, 2017. Therefore, an interim dividend of EUR 0.37 per share will be paid for 2018. The interim dividend will be paid in cash because the scrip option has been suspended until further notice. Our dividend policy remains stable and -- stable to rising going forward. And I now hand back to Thierry for some concluding remarks.
Thank you very much, Maarten. In summary, we made further progress towards becoming a focused high-performing Paints and Coatings company during the third quarter 2018. Profitability increased, both for paints and for coatings, as a result of our pricing initiatives and cost-saving programs despite challenging market conditions, including higher raw material costs and significantly adverse foreign currencies.We delivered on Phase 1 of creating a fit-for-purpose organization and continue to build on our leading positions with bolt-on acquisitions. Completing the sale of our Specialty Chemicals business was a key milestone for us, and we're now taking the next step in our own Paints and Coatings transformation. I'm encouraged by what we have achieved. I'm very proud of what the organization is doing, although we do not expect a straight line improvement to 15%, especially considering the smaller seasonal quarters of Q4 and Q1 ahead of us, but are very much emboldened to reach the 15%.Our updated outlook is shown on Slide 18. We are delivering towards our "Winning together - 15 by 20" strategy and continue creating a fit-for-purpose organization for our focused Paints and Coatings company, contributing to the achievement of our 2020 guidance. Demand trends differ per region and per segment. Raw material inflation is projected to continue for the remainder of 2018, although at a slower rate than during the start of the year. Robust pricing initiatives and cost-saving programs are in place and will remain in place to address the current challenges. We are taking the next step in our transformation to deliver the next EUR 200 million cost savings by 2020, incurring a total one-off cost of EUR 350 million between 2018 and 2020.I now hand it back over to Lloyd for information about upcoming events and for the Q&A session.
Thank you, Thierry. Before we start the Q&A session, I would like to draw your attention to some of the upcoming events, as shown on Slide 19. We will hold an AGM to approve the capital repayment and share consolidation on November 13, 2018, and our Q4 and full year results will be announced on February 13, 2019. This concludes the presentation, and we will be happy to receive your questions. [Operator Instructions] Operator, please start the Q&A session.
[Operator Instructions] The first question comes from Paul Walsh from Morgan Stanley.
In terms of my 2 questions, firstly, Thierry, just on the phasing of the EUR 200 million that you've quantified this morning. How should we think about the phasing of the delivery of that EUR 200 million in '19 and '20, both in terms of the P&L benefit and the cash cost? And my second question. I was a little bit surprised to see the gross margin down a few bps year-on-year in the third quarter. Admittedly, that's on a reported basis. So I guess my question is, given the price initiatives and the positive mix, can you help me understand what's going on in the gross margin level, please, as well? And how we should think about that moving forward?
Yes. Thanks, Paul. Just let me try to get the 2 questions on, but let me start with the second question. When you talk to the gross margin, you probably refer to what we see the contribution margin in percent, I presume.
Yes, that's right. So I think if my math is right, about a 43 number in Q3 this year and it was like a 43.3 number last year. I was just expecting, given the pricing dynamics and the mix for it to have been up year-on-year.
Yes. Okay. So I mean, all right, so that we can handle afterwards. I just want to understand your question. On the phasing of the EUR 200 million and the costs, I think, Maarten, before you give the details, just want to point out that the EUR 200 million is what we will see as the delivered cost savings in 2020. In 2021, that program will actually deliver EUR 240 million. So as some of these things will be implemented during 2020, in fact, the scope of the program is larger than that. And Maarten, you maybe want to talk about the exact phasing that we have here.
Yes. So the phasing of the EUR 200 million savings, first of all, you should think of kind of in 50-50 phasing. So 50%, roughly 50% will fall in 2019 and roughly 50% in 2020, that's the phasing of the savings. If you look at the phasing of the EUR 350 million, I think it's important and that's the one-off cost. It's important to first recognize that out of the EUR 350 million, EUR 60 million is noncash. These are write-downs related to our asset network optimization. So EUR 290 million is really restructuring implementation costs related. How we will look at it now is that we will recognize roughly 1/3 in 2018 in the fourth quarter, the majority in 2019 and then there will be -- still a piece remaining in 2020.
Does that answer your question, Paul?
Sure.
Now on the margin. Yes, on the margin.
Yes. On the margin, I think the way you need to think of, and we've been saying that all the time, is that we focus on with our pricing actions to compensate the raw material impact in an absolute amount. So as reflect, the EUR 300 million of last year, and in fact year-to-date, we talk about roughly EUR 350 million. With our pricing actions, we are focusing on compensating this absolute demand. But from a percentage perspective, that will look still differently, because from a percentage perspective, we will continue to drill as we talk about the margin of 40-plus percent.
If you go through the math, Paul, it's for a 50% margin business. And for raw materials, you would almost have to do double that percentage in price. Now that remains the objective, but that takes longer time and then you'll also have to see where the market goes. So as we compensate for the raw material, we will see a 1%, 2% impact in the percentages just by the pure math of it.
And so in terms of the return on sales margins as it were, that's very much about the cost takeout then in terms of the main levers and any operational gearing you might get from volumes further down the line.
Yes, correct. I mean, so on the pricing, we're not done with the pricing yet. So that actually should give us a bit of a claw back on where we are. But yes, you are right, the rest is really through variable cost optimization, fixed cost optimization, et cetera. Correct.
The next question comes from Tom Wrigglesworth from Citi.
My 2 questions, just as following up on that. Obviously, you've indicated there's about EUR 350 million of costs this year as we look towards the fourth quarter. What is your total expectations for costs now for FY '18? And given you'd had some wiggle room delivered on the third quarter, can you offset that in the fourth quarter? And the second question, just with regards to the -- actually, a mechanical one. The FX drop-through, you had a drop-through in your bridge of EUR 10 million for about a 4% headline impact FX this quarter. When I look at the second quarter, you had 5% FX impact to the EUR 20 million impact operating income. What -- could you just help me understand why the drop-through has changed so much on the FX?
Yes. All right. So on the first one, I think, Maarten, you should probably handle both questions.
Yes. So on the first one, the raw material, as indicated indeed, year-to-date, we are sitting at EUR 350 million. So going forward, we see the raw material impact flattening out, but at a higher level clearly. And you've also seen during the year that the old prices has further increased. So we still see an impact in the fourth quarter. But given the kind of the comps versus last year, that impact is, as I said, flattening out on a higher level. On the FX part, so the FX translation impact you see in the third quarter is very much related to the emerging market currencies. I reflect that the Argentinian peso, the Brazilian real, the Turkish lira. So -- and the thinking is that the impact you see in the third quarter, I think you could also see an impact going forward in the fourth quarter as well.
Just want to point out that in these hyperinflation areas, because that's frankly what those 3 countries are, we do have a very strong position. We are the #1 in South America for Paints and Coatings. So there if you have devaluations of the order of magnitude like the Argentinian peso, which is about 100% devaluation, despite that, I think the team has done extremely good work to try to offset as much as possible. So I think we're encouraged that despite all those pretty big impacts on FX that's been happening, that we actually have been able to maintain our results. So that actually bodes well for the future also. Does that answer your question, Tom?
Yes. Just as a follow-up on the raw mats. So should we expect some acceleration of prices to the fourth quarter? Is that possible within the context of the fourth quarter being a smaller quarter with a [ currency effect ] now?
Yes, well it is. So there is ongoing. There's probably also going to be something beginning of '19, because some of the businesses have more an annual cycle for price increases, and that definitely will be used. Also then, the question. So the answer is yes, because we have the stated ambition to at least offset our raw material costs, and I think we are well on our way to do that. One of the items I want to point out also, because on the volume question, it is because the percentages work out. It would be the wrong conclusion to say that the price increase results to share loss. The overwhelming part of that is really businesses we walked away from, economy line paints in China, we discussed that last time. And in fact, given the raw material evolution, I think that was the right decision. But also like in LatAm, where we -- opportunistic resin sales, big volumes, but there was no margin in it anymore. We took that business out and the cost out at the same time. Some ancillary products like putties, which were often [ told ] for us by the way, where given the raw material and the lack of pricing traction in those segment, we just decided to walk away. Give you an example, in South America, we sell 4x the volume of putties versus what paint is, but all of the money is made on the paint. So the volume losses in our real Paints and Coatings markets are actually very limited. So I just want to point that out that is no wrong conclusion drawn from that.
The next question comes from Tony Jones from Redburn.
I might have 2. Just back on the volume and the value on bottom slicing. You've called out the lower value paint in China and the resins in Brazil and in Marine. But I just wanted to check, is there anything which is more late cycle that we don't see yet, perhaps as contracts expire? So something to think about for Q4 or early '19. And then circling back to Maarten's comments on the raw material guidance. It's right to call out the additional headwind that you see. I'm already modeling EUR 380 million there, which could be far too high. But is it possible you could give us maybe a new range? So EUR 300 million to EUR 350 million or whatever you think is appropriate.
Yes. So Tony, thanks for your question. Let me first handle the third one on the volume and value. To answer your question, not that I'm aware of, so that goes back to the comment I made, around -- I don't see any of our businesses where we really lost volume because of our pricing. And there, I'm talking about the non-bottom slicing, as you call it, in our core business. If I look at it, an impact that we had this quarter, we had made a significant amount of distribution changes, which I think are all for the better. Now of course, if you make a distribution change between the distributor, you're not only -- you have to take the inventory back, which is actually a negative volume at that moment of time. But as -- so that's all in our numbers in the world -- a couple of these events around the world where we did it. Now so in our -- in -- there is no contract, which would be expiring where we feel we're going to fall off a cliff at all, absolutely not. I think we are more assertive. I think we take more drastic actions on our pricing than maybe some of our peers doing. But I think that's just a matter of timing more than anything else. So there, I think there's no other shoe to drop that I'm aware of that I see coming in our portfolio. On the raw material guidance, Maarten, if you want to make some comments?
Yes. So I mentioned earlier the EUR 350 million and indeed that the raw material prices are up. And we see them flattening out at a higher -- although at a higher level. If I would give a number attached to this, I -- the current thinking would be more around the EUR 400 million number. I'm careful to be too specific. And I think it's also important to mention, too, that this includes impacts also of increased logistic costs and packaging material, et cetera. But that is kind of the way you need to think about it.
The next question comes from Gunther Zechmann from Bernstein.
Staying with raw material costs, I'm afraid. What's your outlook for 2019? You mentioned that it's flattening. But for this year, it should be somewhere EUR 350 million to EUR 400 million. So if we just assume a straight line, that's just from a lapping perspective. It should be half of what we've seen in 2018. Now that's the first question, if that's the right way to see it. And the second on pricing running against that. You mentioned in the release and on the call that you have further price increases that you're looking to implement. If you only take the currently announced price increases that have gone through in the market, would that be sufficient to offset next year's raw material cost inflation?
Gunther, thanks for your question. Of course, you asked us to have the crystal ball out and see what raw materials are doing. Just suffice to say that the principle we're going to be holding is whatever raw material increases we see, we will pass on through price increases to the market and we'll probably do that more in real time than what the industry has been doing over the last 18 months. So in that sense, we just monitor what's happening, and that's how we do our pricing policy. But more importantly, I think we do expect for 2019, and again these are famous last words because it's probably going to be different, what's happening in 2019. But right now, I think we see it more stabilizing at the level that it's going to be coming out of '18, which is a bit of an upside margin-wise, because if you see how we do that pricing over the year, we basically would have then the full impact of offsetting than anything else. So I think that's on the raw material. I don't know, Maarten, if you want to comment more on that?
No, that's indeed how we look at it. And yes, I'd like to refrain from giving specific guidance on 2019. For us, it's very important that we offset this with our price initiatives. And Thierry mentioned earlier already that we are -- apart from what we're doing in Q4 and continue to do, we're also preparing the price increases on the 1st of January next year. So it is really -- the focus is on the raw material pricing coming in to offset that in a month with our price increases, and that's the full focus. And then, of course, on top of that, the cost initiatives, which we mentioned earlier.
So Gunther, your second question is around how are we going to be versus the raw material with the pricing with what we have in place. I think we -- when we look at all the different segments, everything that's happening, through currencies, et cetera, we do believe we are getting very much at par with what the raw materials is. And then I think with then, the last wave, we should be actually making being at the same level or even a little bit ahead of the current raw material increases by the end of this year. I mean, Maarten, I think that's how we look at that.
Yes, so including the 1st of January price increase.
Correct, correct. Yes. Does that answer your question, Gunther?
Yes. Absolutely.
The next question comes from Alex Stewart from Barclays.
First one on the EUR 110 million program you got going this year. Can I just check whether you mean that you're going to achieve EUR 110 million in 2018, or whether you're going to be at EUR 110 million run rate by the end of 2018? Because they have very different implications.
Yes. Okay. Can we maybe just answer that question first? Because the EUR 35 million in the third quarter, there's going to be about EUR 35 million in the fourth quarter. We had EUR 25 million delivered in the second quarter, and we had like EUR 10 million in the first quarter. So actually, it really adds up to the EUR 110 million that we said. So that's all implemented, and that would be then an underlying run rate of course also as EUR 35 million going into 2019. As we said before, the EUR 110 million was going to be delivered to the bottom line in 2018. So EUR 35 million would be 4 times 35 per quarter, I mean that's what we expect as the underlying delivery of that first step in 2019. Please go ahead with your second question because we interrupted you.
Apologies if you've answered this already and do say if you have answered it. But the commentary in your release suggests that the higher raw material costs have been offset by a combination of pricing, costs and asset optimization and stuff like that. But the bridge in your presentation implies actually just pricing and raw materials. Is it balance? Is it positive? Can you clarify whether pricing on its own has offset raw materials or whether you need the contribution from cost savings as well? And if you said it already, please do shout. I'll just read the transcript, I might have missed it.
Yes. So if you look at price/mix in the third quarter, then that is offsetting the raw material price impact. So price/mix is $140 million and the raw material price impact in the third quarter is $108 million. So indeed, compared to previous quarters, this is the first quarter where in the quarter we are offsetting this. But overall, I think we talked about the total package of price/mix as well as cost savings to mitigate all the headwinds we have from a raw material perspective, but also from an FX effect perspective.
But also, Alex to build on that, we have been saying that the industry, as included since the end of '16 when the raw material inflation started, hasn't really caught up with pricing. And in fact, we made it a very clear goal that we wanted to offset everything that had happened since end of '16 by the end of '18. So there is even some catching up to do from the year before. So that's why we're offsetting what came in. In the last year, already very much, and we're actually well on our way to offset what came in before that in end of '16 and in '17.
The next question comes from Georgina Iwamoto from Goldman Sachs.
I just wanted to see if you could give us some guidance around your corporate costs going forward? I think they keep coming in just a little bit above market expectation. So if you could give us an idea of what to look out for the fourth quarter and then next year. And then if you could also maybe give some comments on how to think about the top line for 2019, how do kind of volume trends look in your end markets regardless of what you're doing on the mix front in terms of your bottom slicing initiatives?
Yes. All right. Maarten, do you want to cover the corporate cost one?
Yes. So on the corporate costs, you've seen that the corporate costs came in at EUR 42 million in the third quarter. I've also indicated that, that is kind of what we see as the current run rate of the corporate costs. So I think it would be fair to assume, looking forward to the fourth quarter, that we are more or less at this run rate going forward. As part of the overall initiatives to further reduce our costs, we're also looking forward to make sure that our reductions in the corporate costs, but we don't give specific guidance on this, how this will look like in 2019, apart from the fact that we have said that by 2020, we are looking at a corporate cost level, which sits in the middle of what it was for 2017 and 2016, which is in between the EUR 115 million to EUR 188 million. So then you talk about roughly EUR 150 million, EUR 160 million by 2020.
So your second question then, Georgina, is around the top line in 2019. Now there's a number of effects that are actually going to be coming in there. FX has been a big impact on this. If you look underlying, I think we feel that the revenue line has been flat despite all the bottom slicing that we've been doing in our business. In Deco actually, we're pretty positive. So the product line that we have right now, we see pretty positive. If I go to the extremes, I would say on China, what is really our Dulux brand, is doing quite well. So I think there's no real worry there. Other key markets like the U.K. are actually doing very well. So in that sense, that is pretty positive for 2019. So in Deco, same is actually for Latin America where we have a very, very strong performance, totally overshadowed with the current FX. But if you look underlying, significant steps in the quality of the business and in size of the business in South America. If we go to our Performance Coatings there, you really go from the extremes. You have Powder Coating continues to be a rock star in our portfolio and really getting to close to double digit, and I think that's going to continue to advance. The other businesses, industrial, [ ACS ], we think that's going to be the GDP-like growth that we will continue. Marine and Protective, that's for us maybe the most difficult one to forecast because on the one hand, Marine is still not back on its feet, and you see that also in this quarter. At the same time, on Protective, which is the other half of the universe in that business, there you do see a significant increase in projects -- capital projects in oil and gas, which is our forte. And then the question is, how much of that sales are going to be happening in '19? So that bodes well for '19 and for '20, by the way, but we typically come 12 months after the start of those programs to put the corrosion or fire protection on it. So for the revenue line, I think we're -- we pretty much see the 2% we gave as a very realistic view for next year, very realistic.
The next question comes from Geoff Haire, UBS.
Just 2 quick questions. One is, I'm just wondering what benefit did you get from the hyperinflation that you saw in the emerging market in Turkey -- I'm sorry, emerging market countries in the top line, if there was any. If you could quantify that. And just how much more bottom slicing is there to go on the portfolio in both Deco and in Performance for next year?
Yes. So on the hyperinflation on the top line, I'm not sure, Maarten, if we've done the additional what the real impact is. But given some of the examples, in Brazil, for example, or in Latin America, if you look in local currencies, in fact, our revenue went up quite significantly just under the double-digit growth, which is actually enormous for the #1 in the market. If you now translate it back, it's like -- it's almost like 18% down, I think, in currency if you bring it back to euros. So I don't know, Maarten, if you can maybe comment a bit on the overall impact?
Yes. So if you look at the impact, it's very much in Turkey, Brazil and Argentina. I mean, Turkey, we've seen an inflation of, what is it, roughly 50%; Brazil, 20%; and Argentina around 100%. So -- and that, of course, drives a translation impact of the results in euros. Plus the fact that in those markets, and we've seen that specifically in Turkey and Argentina, and this is also a consumer confidence issue, which impacts then our volumes and so our top line as well. So that is the way you need to think of it.
Just to give an example. In certain places like Argentina, our -- if you bought the same type of paint beginning of the year and you buy it now, you're looking at 76% to 80% increase in local currency pricing. So it's probably a good investment for people to put their money in paint versus on the bank, I think. So that's one thing. The second thing is around the bottom slicing. I think as we progress, I think we've been indicating that when we did the whole portfolio work, that we identified the significant part of the portfolio that was not generating its fair share of earnings as you would expect. And we looked, I think, we've even discussed that there was this 10% of the portfolio we felt we had to take steps. And part of these steps was indeed getting the prices back in line or take other measures. Some of the segments, in fact, are turning more to the yellowish green as we do the pricing movement. But I think if you talk about the bottom slicing, I would not be surprised that as we go through this movement, there's still a couple of percent of the business that, frankly, is where we decide to walk away from. But I would be hard pushed to put a percentage around it right now. But that's ongoing, I think, when we do the mix [ arrangement ] of pricing where the cost saving work to stay with our 2 percentages growth as we gave -- as the target for the company while delivering on the 15 by 20, and that's -- frankly, all the KPIs to look at is through those glasses. Does that answer your question, Geoff?
Yes.
The next question comes from Laurent Favre from Exane BNP Paribas.
I have 2 questions left on cash flow conversion. The first one is on CapEx. It looks like you're run rating below EUR 200 million. I mean, is this a realistic level given the weak volume environment? Or should we expect that this is a bit exceptional and then that CapEx goes up again next year? And the second question is on working capital and management. I mean, given the inflation in the system, I was a bit surprised by the inflow in the third quarter. So I'm just wondering, again, is there something really exceptional there? Or should we assume that you've kind of [ a new ] area that you can improve working capital management?
Okay. Well, Laurent, let me try to do the CapEx one and then hand it over on the other working capital elements for Maarten. On CapEx, we are indeed somewhat lower on what the normal spend is. We have been saying a couple of times that the EUR 250 million a year should be plenty to cover what we do. As we have been setting up another governance on the capital projects, which is probably a bit more tight than it was before, it's actually an active debate in our executive committee, are we being too stringent now on it? So I think we feel that we're somewhat understanding the capital rate that we should have, although I think we do all the critical CapEx that we need. But there is probably CapEx we could use to get our efficiency on some of the plants up on filling lines, et cetera. And we want to make sure that we don't miss those opportunities. So I think that's more because of the more rigorous system that we put in place, that there is a bit of a delay. In fact, if you look at it, the capital spend is getting back to what it should be. It's more -- I think at the beginning of the year, there was some understanding as we were getting to different controls, et cetera, for that. But I think for the guidance, as we said with everything that we are planning to do, even the changes in our network, et cetera, I think the EUR 250 million guidance for CapEx spend on an annual basis, you should still see as the upper range of what we should be spending to maintain a business like ours. Maarten, on...
Yes. Maybe to add to that indeed for this year, so going forward the EUR 250 million is how you need to look at it. For this year, it's indeed correct that we will sit below the EUR 200 million. So that is in -- that's the correct observation, adding to all the comments Thierry made. On working cap, I think there are few topics there. But first of all, inventory. If you look at the absolute amount of inventory, it's good to note that it includes roughly a EUR 70 million impact from the higher raw material prices. So from an absolute amount, that is sitting in that number. On the receivables, the receivables we saw coming down somewhat in the third quarter. But if we look at total working cap, there's still work to do to further decrease and address this during the fourth quarter, and that's -- that has also our focus.
Does that answer your questions, Laurent?
Absolutely.
The next question comes from Peter Clark from Societe Generale.
I've got a couple of follow-ups on Geoff's question about the bottom slicing. Would I be right in thinking that you're not expecting sort of 3%, 4% to continue for long or repeat? Because, I mean, it seems quite a lot of bottom slicing going on that we saw in the third quarter. And then the second question is around the Marine and the continuing decline in the new build particularly. Just wondering if you are prepared to give us a feel for what the new build proportion is of Marine against the refinish or maintenance as we look at, say, 2018 year.
Yes, on the first question, Geoff (sic) [ Peter ], of bottom -- you can't keep bottom slicing forever, of course, otherwise you have nothing left and we have already been indicating it is not our ambition to shrink. On the contrary, we want to stick to the 2% growth that we have. So I think at one point, I mean this is going to even out. And again, as I'm saying the percentages that we talked about was also [ a lot ] with, I think, good steps we did in our distribution to -- which then also temporarily has an impact on the volume, which you share. So the bottom slice, I think that should go back to normal in the next coming 1 or 2 quarters. I think we should be back to the normal rate. The second thing, on Marine and Protective. I, don't have the exact build numbers here in front of me. In fact, in the third quarter, what we saw was some delays and actually the refinished, the repair part, because that industry is still suffering quite a lot. Having said that, our Marine and Protective business on the bottom line is doing better. So I think that if you would call that bottom slicing, focusing on where we really added value, I think it's working out for the business. So bottom line-wise, it actually looks much more positive for us. But on the volume-wise, I think there you could say we really go through a more targeted approach. But I -- we can follow up Lloyd. I mean, I don't have the new build numbers in front of me.
Okay. I'll just follow up.
In the past, of course, it's about 50% in new build versus the maintenance. But that shifted with the declines in the new build, which have been double digit during the last 12, 18 months.
The next question comes from Mutlu Gundogan.
Two questions on volumes. And apologies, maybe I missed it, but did you quantify the impact of the bottom slicing in the third quarter?
Yes, well, we did. So I mean, if you look at the 6% in total, half of it is actually very consciously us stepping away from those volumes. That includes the low economy lines and ancillary products in China. Same as I said, ancillary products like putties, et cetera, in Brazil and some opportunistic resin sales that we had, all big volume items, but frankly with not much margin even historically associated with it. So that's about half of it. The other half of the volume is basically split between the ups and downs in specific markets also because we're more aggressive on price. So there is some temporary impact there plus other elements around supply chain, et cetera, that we've done -- that basically is the other -- I would say the other half of the half in the volume.
Yes. Plus what we mentioned earlier, the lower volumes of Marine and Protective, which is basically market dynamics.
Yes, correct.
Yes. And then another question on -- you said that you expect that to normalize in maybe 1 or 2 quarters. So would you say that the 6% decline that you report is the low point?
Well, it's not the intent to keep it at that level. I mean, that's definitely correct. If we look at what happened in the third quarter, I would say there is a number of things coming together. Don't underestimate that also for the hyperinflation countries. We talked about the currency. But can you imagine if you're a distributor in Argentina or in Brazil or in Turkey, you don't necessarily want to order your warehouse. So you manage the cash, et cetera. So that has an impact where people really almost do what they have to do. So I would say that is probably a lower point. But to be very honest, it's not a KPI that we follow because as we go to our portfolio work, frankly, if we see elements where through pricing we can redirect resources to businesses that have much higher value and actually would have a much higher growth potential, we will not hesitate to walk away from just volume that has no value associated with it. And that, by the way, creates opportunities for our whole network to get it much more tighter to basically work on our cost base. A good example I gave is in our teams in Latin America who walked away from opportunistic resin sales, big volume, but no margins associated with that. And at the same time, took out the costs -- the production costs and the -- all of the costs associated with it. So I'm not adverse for doing those actions where it makes sense.
The next question comes from Markus Mayer, Baader-Helvea.
Two questions left. The first one is on your competitive environment. Over the past years, it looked like that your competitors were quite aggressive at least trying to gain market share. And now it looks like that they also have quite significant problems on the relative cost side. Do you see a change in their business behavior in their respective markets? And secondly on -- again, on Marine Coatings. In the past, also higher oil prices always are good trigger for higher volumes when it comes to the maintenance work of the ships. Is this something you expect to happen over the next quarters?
Thanks for your questions. To -- on the first one, the competitive environment, I think it's fair to say that we've probably been more assertive on pricing because we have the value over volume. I mean, nobody here gets a salary paid by share, it's by the money that we make, so that's what we keep focusing on. So it's twofold. I think the big players, we do see in different degrees of trying to get their prices in line with raw materials, because the raw material impact has been so significant that you can't ignore that for very long if you want to do the share gain. So I think that's happening, maybe with a bit of a lag, maybe at least in our perception, but I think that hopefully will come in those markets. What we do see though in specifically some emerging markets, and that's in the segments where we consciously walked away from, you have some local players, smaller companies then who frankly, go after business where we believe that they really are not making any money anymore but just keep the volume. We've seen that in fact in some of the tenders in Marine and Protective, where we -- frankly, if we do the simulation of where raw materials go and then the tender prices where they go, we know that it actually is going to be at the zero-sum game to go there. And in addition, these are complex markets with quite some liabilities associated to it, so that's why we actually didn't want to go there. So it's probably more the smaller players we see diving onto some of those peripheral businesses. The second thing around oil and gas. Yes, Marine does respond to oil and gas. We haven't seen that just yet. So that is maybe coming. But again, that may be with a time lag. We haven't -- we are not building our 15 by 20 on a big recovery in Marine. If it comes, it's a plus. If it doesn't, well then we have the plans in place. For oil and gas market themselves, that's where you see really the pipeline filling off capital investment by the oil and gas industry. And there we have had traditionally a #1 role, very good value businesses where we have the right portfolio. So there, we're a bit more optimistic to see that coming. But that's probably going to be more in -- as of the second half of 2019, depending on the length of these projects on how to get [ value there ]. Does that answer your question?
Yes, very clear.
The next question comes from Martin Evans from HSBC.
It's just a very quick presentational question actually on the margin.
You're very hard to understand.
Yes.
Can you hear me now?
Yes.
Yes, loud and clear.
Sorry about that. Just a very quick presentational question, just -- and you probably answered it before. On ROS, the margin calculation and the fact that, if I'm correct, on the 2 key divisions, Coatings and Paint, you haven't allocated any corporate center costs, therefore, the margins would appear to be sort of probably 200 basis points higher than they might be if you did. Can you just -- if that's correct, can you just sort of remind me of the rationale for not allocating corporate center costs between the 2 remaining divisions. Is this simply due to the dislocation from exiting Specialty Chemicals, and therefore, you will subsequently restate at a lower level or not?
Yes, well, good question. So the short answer is yes, because when we came out with the 15 by 20, that goes back to April 19, 2017, that's when we were still one company. So we wanted to make sure that there was no confusion on what numbers we're talking about, and also it wasn't very clear that moment of time which cost would exactly go where with Specialty Chemicals and now [ Zweikorn] and then with us. So that's why we focus on the businesses. We also have been saying though that there is a bracket with these corporate costs, so there is no moving tricks here by having costs going to the corporate level. Now we've actually chosen to -- and we actually will continue to do that to stick on what the businesses deliver under the premise that the corporate cost is very well maintained and contained, and there's a lot of effort on that one to draw -- to bring it back, too. So that's why [ when you read ] the 15 by 20 refers to the businesses. But that has -- I think we've made it pretty clear every step of the way since April 2017 what we're talking about. Maarten, I don't know if you want to add more comments on that, but...
No. I think this is exactly how we have positioned this and I think it's important to be aware.
And in fact, we have what actually is working very well for the company that was probably a bit more decentralized if you go from any plants deep somewhere in China to Brazil to the U.S., to -- in Europe. 15 by 20 is tattooed on everybody's left shoulder. So if we now start changing that number, we have to redo the tattoo and that will be a waste of time. So that's why we stick to that target internally and probably also externally.
This is all the time we have for questions today.
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