Concentric AB
STO:COIC
Earnings Call Analysis
Q4-2023 Analysis
Concentric AB
The company has been facing a consistent challenge with maintaining profit margins. For the past eight reporting quarters, two key cost drivers remained static, with margins hitting 16% in six of those quarters. The pivotal issue disclosed was higher capacity costs in the later quarters relative to sales, which has initiated a drive to reduce the cost base and restore margins to acceptable levels.
Market growth for electric products is an integral part of the company's strategy, with a projected 14-15% CAGR over the next five years. This growth encompasses both existing markets and new, higher-growth end markets. Already embedded in the company's planning is the expansion into suitable new markets that are aligned with this growth narrative.
The company is expecting margin improvements in the coming quarters despite anticipated lower sales. Executives expressed confidence in a quarter-on-quarter margin increase in Q1, credited to cost-saving measures. However, they stopped short of providing specific guidance on cost savings or exact margin improvement figures.
As the company explores entering new markets, the focus is to maintain current margin levels without dilution. The new markets identified are similar in margin potential to the company's current average, ensuring that the company's profitability isn't compromised as it diversifies its market presence.
There is uncertainty regarding market recovery timing, particularly in traditional segments like engines and hydraulics. Sales in these segments are expected to be lower in the first quarter. The company also acknowledges challenges in tracking exactly which applications their products are utilized in, given the crossover of products across fully electric, hybrid, and partially electrified applications.
The company has highlighted a key investment in high-voltage manufacturing equipment in North America. This move is driven by the demand in new end markets, particularly the transition towards high-voltage applications. Such investments mark a strategic pivot towards aligning the company's production capabilities with future market demands.
The data center cooling market presents a huge growth opportunity, driven by an industry-wide shift towards liquid cooling technology. By 2030, it is expected that 30% of data center solutions will be liquid-cooled, up from virtually none today. The company sees this as a rapidly growing segment due to advancements in processor technologies necessitating more efficient cooling solutions.
The company has been successful in passing through cost increases to customers, which has helped maintain stable margins. With minimal material inflation expected in 2024, the company does not anticipate a need for aggressive pricing activities. Pricing increases are typically passed through to the end customer with little lag and seldom do they receive retroactive price increases, contributing to consistent margins.
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Good day, and thank you for standing by. Welcome to the Concentric presentation of the results for Q4 2023 conference call. [Operator Instruction] Please be advised that today's conference is being recorded.I will now like to hand the conference over to your speaker today, Martin Kunz, President and CEO. Please go ahead.
Yes. Thank you very much and good morning, everybody. Very warm welcome to all participants in the Q4 presentation, both here in Stockholm in person, as well as out there connected by a phone. This is our Q4 results presentation. I'm here with Marcus Whitehouse, our CFO. And so let's kick off.Q4 has been a challenging quarter for the business. We have seen a combination of significant destocking activities with a weaker market, which led for the business to an underlying sales growth of minus 9%. So our net sales have actually ended up significant below our expectations at the end of the third quarter at SEK 945 million. However, the sales of our electric products have remained strong in the quarter, which is always a good indication for the execution of our electrification strategy. And on our electric sales, with the 24% in the fourth quarter, we afford to reach 20% for the full year, which was our original '25 targets. That means we have reached our '25 target 2 years ahead of our original plan.The book-to-bill ratio in the quarter was 89%. Also here, electric products stood out with a book-to-bill ratio of 100%. So with the sharp drop in sales, our operating margin went down to SEK 115 million in the quarter, which corresponds to an underlying margin of 12.1%. And Marcus will walk you later in the financials through the details.The quarter has been very strong in terms of cash flow. So cash flow from operations was SEK 227 million, well above the same period last year. And at the same time, we also had very good progress -- ongoing progress in the execution of our strategy in terms of electrification and new markets.So when we look into the market for the fourth quarter, so the published market indices suggest that basically on the production rates that were published that the market has been broadly flat. The engines market was slightly up, whist the hydraulic market has continued to contract at minus 10% in this quarter. However, when you look at the demand from our customers versus the market indices, there has been a significant gap, which is partially because this is a quarter and we have to look at the full year, but also, as I mentioned before, the significant destocking activities that happened during the quarter from our customers.So Europe has remained a challenging market, more challenging than North America. And when we look at the picture from '22 -- '23 going into '24, it's clear that we're seeing a weaker market in '24 than what we have experienced in 2023.So with that, I'll move on to strategy update. When we look at how we accelerate our electrification, there has been, I think, a very important event happening in the quarter. We won our first business nomination for a data center liquid cooling application. That is a market that we have been working on, but that has been the first breakthrough with a global OEM that will launch production with our pumps in it already in the first quarter of '25. So not so far out. And this is, in particular, interesting because it fits very well into our strategy.Data center cooling is a fast growing market. So when we look at the growth rates for that market, in particular, the liquid cooling, within a market that has traditionally been air cooled, is an area of significant growth that we can participate on.The second element of it, it's obviously done with an existing product. So it has not been a new -- it doesn't require any new product development. So that was clearly a highlight in the quarter.And we also have entered in another new market, which probably those of you who have been reading the press release in the last days is trailer electrification. And that's a complete new market. So trailer is completely different from truck. The trailer electrification basically means that the trailer itself is powered. So it has actually its own power system that allows the trailer to be moved at the yards, at the dock or even give additional power to the truck when it's on the highway.And in this interesting application, we have both our electric fans as well as our coolant pump in a combined system. And the interesting aspect of the trailer electrification market is it's completely up for development, and it also offers the possibility in the future that even existing trailers can be basically retrofit with that technology, and it's absolutely technology agnostic.So it supports both traditional internal combustion engine trucks, but also fuel cell trucks or petro-electric trucks. So whatever technology the truck uses, the powering of the trailer contributes to emission reduction, and obviously, the overall climate targets that we're all pursuing. So very interesting application and very interesting customer. And I have to say that both of them are completely new customers for Concentric.So when we look into -- and I think its worth with those 2 business wins to look back in how we have been doing in entering new markets. So remember a year ago we were here and we spoke about new markets, and then we continued in the Capital Markets Day in May, we only had one new market that was outside our traditional commercial vehicles, which was energy storage. That you all know we have been supplying into that market for a few years.Now if we look into where we are in February '24, we are already basically active in 4 new markets. So in addition to energy storage, we -- as I mentioned, data center application gets us into a very interesting market. We have launched in July last year an application for actually a fuel cell power generator, where we sell our high-voltage fans. So power generation to replace the diesel generators out there. Fuel cell is one of the most suitable technologies. So we have a customer where we have developed an application with that. And last but not least, the trailer electrification that I just mentioned. So pretty interesting progress, growing into new markets as a part of our overall electrification growth strategy.To close off the strategy update, we had another good quarter in bringing prototypes for our products to our customers. And that is basically confirming 2 trends. First of all, our products -- our electrified products continue to enjoy a high level of interest from customers around the globe. But there's also a second confirmation of a trend. We are leading in high voltage and the fact that our high voltage products are in high demand for prototypes also means that high voltage itself is an ongoing growing market trend in the electrification market.And some of the prototypes, as I explain every quarter, are actually not just prototypes. They are also pre-series or small series manufacturing components. And once the customer has actually the economies of scale, they turn into production orders.I'm happy to take questions later on in the Q&A session. And for the moment, I hand over to Marcus, who will walk us through the financials. Marcus, please?
Thank you, Martin. Good morning, everybody. Let's move on and talk about the financial results for the fourth quarter and full year.First things we'll start within -- Martin has already touched upon this -- which is what's happening within the market. The market has continued to be 2 very distinct parts of the year, the first half and the second half. Second half heavily influenced by destocking in the general weaker market. And we first saw that in the third quarter. It has continued on and probably progressed a little, meaning the sales that we are reporting today are a little weaker than we were expecting in that fourth quarter. And that is entirely due to rescheduling of orders within our main customers and a generally weaker market in which we are operating.So overall, we are reporting ourselves for the fourth quarter at SEK 945 million, down 9% year-over-year and no exchange movements. We're seeing the same sort of trend on our 2 divisions, engines and hydraulics. Engines was down 5% underlying in quarter 3. It's down 5% in the fourth quarter year-on-year. So engines is continuing to be weaker. But hydraulics has really been impacted in the second half of the year. We were down year-on-year 12% in the third quarter. We're down 15% in the fourth quarter. And the graphic below shows you how that 9% splits across our 2 divisions pretty much evenly, 4% of the 9% is due to engines and 5% of the 9% is due to hydraulics.Now clearly, that drop in sales is going to have an impact on our operating income and our margins. And we have reported today that our operating income before items affecting comparability is SEK 115 million with an underlying comparable operating margin of 12.1%.Now clearly, that is not where we would want to be, and therefore, much of the activity that we have had ongoing in the fourth quarter has been about a cost down program. Now that cost down program has been sort of implemented late within the quarter, so the financial benefits of that program won't influence the fourth quarter. But the majority of that program will start to influence the first quarter of the New Year.As you can see as well from the graphic, the drop in the operating income from last year, SEK 172 million, down to this year of the SEK 115 million again is pretty much evenly across those 2 reporting divisions, SEK 31 million in engines and SEK 26 million in hydraulics.Now for those of you that look a little bit further down the P&L than just the operating margin, and there will be some, you will have noticed that the corporation tax charge in the fourth quarter was low. It came in at SEK 4 million, 4% of effective tax rate. And that low charge in the fourth quarter is all due to one thing and one thing alone, and that's a tax rebate that we've managed to secure in North America, covering tax years -- or covering financial years 2022 and 2023. Had that not been achieved, our underlying effective tax rate in the fourth quarter would have been 23.6%, 24.2% for the full year, representing the tax jurisdictions in which we operate around the globe. A little bit of good news for those followers of the EPS.Moving into our 2 divisions. Now we always start with engines. We'll continue to start with engines. And I'll just guide you to the top graphic and the bar chart. On the bar chart, those 4 grey sort of bars that we've got within 2023. And you can see what we've been experiencing during 2023, a slowdown of each and every one of those quarters over the year. And as we talked about earlier, we've seen a 5% drop in underlying sales in both the third and the fourth quarter.The interesting thing to be looking at in this slide is the book-to-bill ratio. We saw the book-to-bill ratio at around about 196%, 107% in the first half of the year, and so still holding strong. And then we've seen it start to weaken in the third, down to 93%. And this quarter, we are 85%. Strangely enough, a number that we reported for the first two quarters of hydraulics.It should also be noted within that 85%, with engines having the majority of our e-products and our e-products remaining strong, we've got a weaker position within that market on our base mechanical pumps to engines, suggesting that the engines market is slowing at a later rate than what we had within hydraulics and perhaps suggesting we haven't quite found the bottom yet within the engines division.The impact of those lower sales has obviously impacted the operating income, and we've reported that at SEK 87 million and an underlying operating margin at 13.2% in that quarter. One thing to note is just really to draw out the impact that Alfdex is going to have on the engines division. And Alfdex overall has had a pretty much similar year, 2022 to 2023. However, 2023 has been more consistent. 2022 was very lumpy, influenced by China. And this quarter has got Alfdex comparing Alfdex's strongest performance Q4 '22 to Alfdex's weakest performance in 2023. So we have got a little bit of margin movement in there by mix of that joint venture with Alfa Laval.As we move on to hydraulics, and as we touched on earlier, hydraulics felt the slowdown a little earlier. The underlying sales in the fourth quarter are 15%, as we touched on, 13% in quarter 3. However, again, looking at the book-to-bill ratio, it was weaker, 85% for the first 2 quarters of the year and has steadily progressed in quarter 3 and quarter 4. This quarter 99%. Again, perhaps suggesting that hydraulics business may have found the base in the cycle, may.Operating income and operating margin have really been impacted heavily, though, during these last 2 quarters with those fairly substantial drop in sales. And again, a big part of what has been done there is therefore to restructure the cost base for the hydraulics business to get that margin back to a more acceptable level of profitability for the coming quarters.I saved the best for the last, the cash flow, working capital and gearing. If you look at the top left graphic, the bars are the cash flow per share. And again, the shape of how we generate our cash. 2022, 2023 is fairly consistent. Fourth quarter is typically the strongest. And this quarter, we've had a really great cash flow, SEK 227 million that's being delivered, 280-ish profit to cash conversion, SEK 140 million for the year. And that SEK 140 million has then benefited from some working capital improvements and inflows that we've had, of which a bit of that has been destocking.The more comforting bit within all of that is the line that we've got on that top left graph, which is effectively our working capital as a percentage of sales, which has steadily and progressively lowered over the last couple of years, helping us to generate the cash.Strong cash flows and working capital management have, therefore, allowed us to continue to pay down the debt. So our net debt now is SEK 617 million compared to SEK 925 million this time last year. Our gearing ratio is reduced. We're now down at 28%, fairly low level of gearing, compared to 45% this time last year. And I've just introduced the net debt-to-EBITDA ratio -- it's something we touched on in the Capital Markets Day -- just to reassure investors about where we're at on the level of risk. And we have plenty of debt capacity still [Audio Gap] is now at 0.8% compared to just over 1% the same period last year.We also have continued to do the own share buyback program under the safe harbor rules. We bought back about SEK 34 million of shares in the third quarter. We've continued to buy back in the fourth, SEK 66 million. So SEK 100 million has been purchased over the second half of 2023.And even though we've done the own share buyback, our cash and cash equivalents remains strong. We finished the year at SEK 724 million off SEK 100 million year-over-year. So our balance sheet remains in a really good position, both from working capital where we end the year, in terms of our gearing and our EBITDA to net debt ratios. And the amount of liquidity that we have for the business ensures that we've got the firepower to do acquisitions as and when they present themselves. And we have plenty of liquidity should an economic cycle throw any more challenges at us in 2024.With that, I will hand you back to Martin to conclude with the outlook for Q1.
Yes. Thank you very much, Marcus, for the details. So Q4 is behind us. And going into '24 what does it mean? What are we seeing in terms of market and outlook? So first of all, the uncertainty in the business remains. I don't have to go into the detail. Everybody is familiar with high interest rates basically impacting, for example, the sales of all capital goods, et cetera, et cetera. Based on the information we have today, we estimate that our end markets will be weaker in 2024, and we also expect that the sales in the first quarter will be slightly lower than the sales we have achieved in the fourth quarter.So in the first quarter -- Marcus mentioned already the restructuring program. We have aligned our cost base with reduced demands from our customers. That will enable us to return to improved levels of profitability. And if the market basically goes further down, we will take additional immediate actions to further adjust the cost base if necessary.The demand for our e-products, we have mentioned it already. Strong fourth quarter for e-product, strong year '23 for e-product, ongoing good book-to-bill. So demand for e-products is expected to remain strong. And the wins that we have materialized during the entire year 2023 bear a potential to accelerate the growth in our electric sales through the development of either existing as well as new markets.And that concludes our presentation. With that, I'll open up the floor for questions, as usually, here first in the room in Stockholm, and then we move on out to the conference call.
Julia Utbult with SEB. And my first question is if you could clarify that what the book-to-bill in engines and hydraulics tells you? You mentioned that we might not seen the bottom yet in engines while you are more positive in hydraulics. Did I get you correctly there?
That's about right. But we have to separate engine between our mechanical products and the electric products, where, as we said, we are seeing an ongoing strong book-to-bill for electric products. So we have a mixed bag between the 2 parts of the business in engines.
Yes. On balance, we still think there's a little bit of downside. And hence, why we're guiding that the first quarter will be slightly weaker. We still think there's a little way to go on engines. Hydraulics may -- and I say may because it's still quite uncertain. But it's starting to feel like it has hit its bottom.
And the current cost reductions are already having this into calculations then. Okay. Perfect. And on the margins there, could you give us more flavor on why the margin is declining quarter-on-quarter?
I mean, the answer lies in the fixed cost...
It's purely -- yes, I'll pick that, Martin. It's purely we -- if we look back at our group as we have at our contribution margins that we have got, both our direct and our labor, the 2 biggest cost drivers that we have, they are pretty much static right the way across 8 reporting quarters that we have. Our challenge that we have now, and again, over those 8 reporting quarters, 6 of those quarters, our margins have pretty much been 16%. So the influence that we have got is the fact that our capacity costs are just higher in Q3, in Q4 relative to the sales that we are enjoying. And that's why we've got to address that cost base to restore the margins back to an acceptable level.
Perfect. And then you mentioned the new end markets that you are entering, which were not announced or so much focused on during the CMD. And there you forecasted for a 14% CAGR in market growth for the electric products. Does both new end markets change anything in that guidance since those end markets have a higher growth rate?
Not necessarily. I think the -- it was -- by the way, it was 15% what we said CAGR in the Capital Markets Day for the next 5 years in electric growth. We had already factored a part of that growth from new markets, but we were still looking at what are the most suitable new markets. So that has been part of the game plan.
Perfect. And then one final question from me. Can you give us more -- a clearer number or anything guiding us on the potential savings from the cost reductions? And what pace and how you're coming back to higher margins both in Q1, but also 2024?
Yes, that's the difficult question, Julia, to answer. We won't give guidance on what the cost savings are likely to be. We are expecting our margins -- and again, we're not going to give a number. But we are expecting our margins to improve on the first quarter despite the fact we're likely to have lower sales. But we won't give guidance quite yet on what that is likely to be. But we are expecting a quarter-on-quarter margin improvement in Q1 despite us having lower sales.
More questions in the room?
Mats Liss, Kepler Cheuvreux. A couple of follow-ups, I guess. In these new segments, I see a lot of opportunities, of course. And you mentioned the electrification. And you also saw this new segment coming up in the quarter, data center. Could you say something about sort of how the growth cycle progress going forward? Is it sort of something that will see more about in 2025 when maybe end user segments in the more traditional markets are sort of stabilizing and returning to growth?
Yes. A good question, Mats. So when you speak about the traditional segments, are you referring to electrification or to basically all products?
I mean the engine and hydraulics in the more sort of traditional powertrain applications.
Yes. I mean the market indices for '24 suggests the weaker market. When does the market recover? I mean that's a good question. I think we have to see really. As Marcus has said before, we believe that -- on the hydraulics side, we feel that we have reached the bottom, yes, but we're not yet certain about it, yes. On the engine side, there might be still a bit of movement, which -- that's why we're guiding also towards a bit of lower sales in the first quarter. So we have to see how the market recovers.However, when you look back at press releases we have issued over the past 24 months, there are, in general, new business opportunities that are coming in, that are ramping up, that has dates behind, yes. Some of them comes in, in '24. But there's a lot of new stuff coming in '25. So we have to see how the market performs. But we continue to drive our growth agenda, both on the mechanical side as well as on the electric side.
And could you just, well, remind us maybe on the sort of potential impact on margin there? I mean will there be a mix change to both electrification and -- I guess, it's early days for that segment. But should we expect the margin to be in line with what you're counting...
Absolutely, absolutely. There's no change to that statement. I mean, even if we go into new markets, the ones that we mentioned, they're all about the same margins that we're enjoying today at group level in the average. So there's no margin dilution coming going into those new markets.
And then about -- yes, you mentioned that you see a margin improvement in the first quarter here due to the cost measures you have implemented. And I guess that's good. But could you give some flavor in absolute terms? If I remember right, you had some cost of SEK 10 million extra in the fourth quarter. How much did it reduce the cost base?
That's actually -- I'll refer that to Marcus. We have to stay with the same answer here.
Yes, we're not guiding on the amount of cost again. The only thing we're guiding on is the margin is going to improve from where we were in the fourth quarter. That's as far as we're going on guidance at the moment, okay.
And finally, just about cash flow. I mean you mentioned you've been good with reducing working capital. And is it sort of finalized for your -- for the time being? Or are there more to be done?
There's probably a little bit more on stock, but not probably a whole lot more in terms of what we got. We had good progress in the fourth quarter. So I'm not expecting huge working capital movements over the course of the year.
Yes. But we continue, in particular, on inventory, Mats. You shouldn't forget we're coming out of the 2.5-year global supply chain crisis with extended lead times. Everybody was holding higher level of stocks to basically keep the business running. And so lead times are getting shorter as we see it, but it doesn't happen overnight. So I think inventory remains on the agenda for '24.
And finally, just about -- I mean, your gearing come down quite nicely and I guess markets are slowing. Do you see opportunities to move ahead with more acquisitions given -- I mean EMP was a huge one, but...
Yes. I mean we're permanently looking at acquisitions. You know the criteria that we are applying, what makes a company attractive to be an acquisition target for Concentric. And we are permanently looking at good acquisition targets that support basically our growth agenda. And as Marcus has said, the balance sheet is very supportive of that.Any more questions in the room? Julia?
Julia Utbult with SEB again. So you had a strong development in the electric products in the quarter. Could you tell us more about what end markets drive this top line growth?
Yes. I mean the end markets are largely the same that we are targeting. So in particular energy storage is one that we have to call out, which is helping us as the first new market than our traditional truck and bus market in North America. EMP traditionally has held a very strong market position in the market for transit buses in the U.S., both fully electric as well as hybrid. And then we are going into new applications with all sorts of new vehicles, yes. So it's really across the board. It's a broad range of customers and applications that we are targeting. And that is also what is giving us this ongoing growth.And I always refer back to the prototype statistics, right? It's always difficult to say. You have a market here, yes, and you have existing sales there, how do you bridge between? There are a few indicators that tell us that we're on the right way. And that is the demand for our prototypes going into new applications that then have to be tested, have to be validated, and finally, after most likely 2 or 2.5 years or even 3 years, end up in the production order.So it's to your question I know a long answer to a short question. It's a broad range of customers and end markets that we continue to target, plus the new markets, as Marcus said, that obviously come into the mix and provide additional opportunities.
And how large a part came from fully electric vehicles?
This is a number we cannot say because many customers actually use the same product on a fully electric platform as well as on a hybrid platform. Or it might be even a partially electrified application on an ICE vehicle. So we cannot even say where the products end up, exactly in which application. It's difficult to find out.
And then you mentioned that you are doing facility investments to meet the demand in those new end markets. Can you give us some guidance or any flavor on what facility investments you expect?
Yes. I mean, we have mentioned it a few times also since the Capital Markets Day one of our big investment right now is in North America in the previous EMP side on the new high-voltage manufacturing lines. Basically, when you go back to the numbers that you see on prototypes, those turn -- not all, but many of them turn into production. So the biggest investment right now is actually in the high-voltage manufacturing equipment in North America. But we also continue to invest in other areas, both in the traditional mechanical business as well as in other parts of the electric business.
So I think if we have no further questions in the room, I suggest that we open up the floor for the participants that are out there in the conference call.
[Operator Instruction] We will now take the first question from the line of Bjorn Enarson from Danske Bank.
You have a very high drop-through on EBIT on the 5% decline. Can you give some comment on your production? How much did that decrease? I mean, OEMs are destocking and you're yourself selling out on inventories, I guess. But -- so production is, I guess, a better leading indicator on why EBIT fell so much.
Yes. Bjorn, it's Marc. Yes. Look, we've got some challenges within that fourth quarter results that you're picking up on. So yes, production's rate dropping. There're some inefficiencies on some of the labor and some of the variable overheads. The primary thing, though, and the thing that we're guiding towards is we just have too much capacity cost. That is the essence to all of it. And that's the major focus of what we've been doing during the fourth quarter is to rightsize that cost base to get the margin back. So yes, as sales drop inefficiencies creep in. But it really is rightsizing the capacity cost, is the focus area and where we've put the energy in the fourth quarter to help the first quarter's results.
Okay. Got it. And you touched upon it, but I was thinking about your end markets and when destocking is done. But you -- as you are thinking that maybe hydraulics are at bottom or at trough levels maybe as -- I guess that also reflects that the destocking may be begun for that division.
Yes. Well, that's what we're hoping and feeling. The book-to-bill ratio is guiding us towards that. You never can say it's done. That's the thing we can't say. But with the book-to-bill ratio starting to recover to sort of 99% of sales in that quarter, it's starting to feel like hydraulics has perhaps found its bottom. What we do know and what you can see with that book-to-bill ratio for engines as it started to weaken over the last couple of quarters, it's suggesting that there is a little bit more ground to go within that division. Again, we'll feel that as we get into this first quarter, but that's what the data is starting to indicate.
And looking at the outlook for some of your end markets, I mean, they are quite negative. And I guess, primarily, that will hit the OEMs in the second half with good production rates first half. But you guys have a little bit of a different cycle. Can you help us to go through that? If the scenario would be that major OEMs will decrease production quite significantly in the second half, but hold up production first half, how would you play out in such a scenario?
Bjorn, this is Martin. So I think we have to go into the end markets and look at them end market by end market. So when you look at hydraulics, our largest markets for hydraulics are actually construction and agriculture. And obviously, we think that those markets are now reflecting where we are.When you go into truck -- and you're referring to probably the first half versus a weaker second half. That's what right now the truck market indices suggest, more or less a slightly lower first half of the year, but then probably a further decline in the second half of the year. That's too early to tell whether it happens or not. But it's clearly a difference here between the different end markets and how they turn out in '24.
Yes, I understand. But I mean, if we would see that scenario as you described on engines, how would that impact you guys? Because there is also -- I mean, you're also already seeing the weakness as the OEMs are also destocking. So the underlying demand is higher where you are. So maybe it does not mean that your production will decrease even further -- or it will decrease further, but I mean not to the same extent maybe.
Yes, that's a good question.
Yes. I mean we -- I mean we don't guide beyond that first quarter. So trying to predict what we think is going to happen in the second half of this year is going to be a challenge for us. We absolutely get what you're saying. Yes, folks are talking about it. But it's always difficult for us to work out what's happening now in terms of that sort of bullwhip effect that comes through with the OEMs that are adjusting stocks and have an impact on us, and then where it ultimately settles out. And that's really difficult for us to make a call on at the moment as to what's really happening within it.So we'll have to reserve guidance for the latter half of the year until later once we see where we are. Our first big test now is just seeing whether we find bottoms within that first quarter and get a better feel for the market. As Martin said, there's still an awful lot of uncertainty that's out within that marketplace. And we're just trying to feel our way through it. But -- so yes, second half a bit of an unknown for us at the moment. We're very much focusing on getting this right for Q1 and Q2 of next year.
Got it. And when you're talking about restoring profitability, you said that you expect higher margins sequentially despite weaker sales. That's very good. But is restoring also -- I mean, is that flattish year-on-year? Or what should we think about in Q1?
Well, it's a recovery. So I don't think we're going to get back to minimum targets, but it's certainly an improvement over where we were in the fourth quarter. I won't give an absolute number to it as much as -- I can see everybody is looking at me saying the number. I won't give an absolute number. But we are looking for an improvement in profitability with the cost-out program despite weaker sales in the first quarter sequentially from 4 to 1.
And if I may add, Bjorn, the cost-out program is largely executed to give us the confidence that we're achieving higher profitability despite slightly lower sales.
And last question. Maybe you said this already, but these 4 new markets that you have been presenting now and since the CMD, size-wise are there any color on that, that you can help us with? How big would this market be? Or...
First of all, the markets that we have selected all have attractive growth rates. So the criteria why we selected them is, first of all, they have to have attractive growth rates; and second, we must be able to serve them with existing products. So -- and the markets we are calling out right now, Bjorn, are the ones where we have solid information that are in development.I'll stay for the moment with the data center market, which is a very interesting one. It's a huge market. And if you read the newspapers every day, the new processor generations for ChatGPT and AI are enormously powerful. They can't be cooled anymore with a traditional air-cooled solution. So it has to be liquid cooling.But it's a market that is in development. The first applications are coming out now, but there is very, very good growth to be expected for the next 5 to 6 years. And we believe that this growth will happen very fast because the new processor generations are already out there. But we have to go in the details of every market. But the markets we're targeting right now are all attractive regarding their expected growth rates.
The next question comes from the line of Hampus Engellau from Handelsbanken.
Can we say that -- the electrical side here in these data centers, could you maybe mention some of competition here for you guys? And I mean, we all say that the data center market that's, I mean, very big. But from your kind of product offering, I'm sure you've bridged this in your numbers and made an estimate on what type of potential this could do for you guys? Could it be possible to maybe not just talk about the growth number -- of course, it's going to be high given that you're coming from very low levels. But in absolute numbers it would be interesting just to get a sense of how you view this going forward? That's my first question.
Hampus, this is Martin. Interesting questions, but I think we're not yet there. These are new markets where we have to get a better feeling about. I mean, we know which products we can sell into those markets and in which systems by the customer they end up. But if that -- let me call it the growth that -- if you look at the data center -- the data center cooling market in general has a huge growth. And the other component that is the interesting one for us is by the year 2030, 30% of the solutions will be liquid cooled versus literally 0 liquid cooling today. So that's the data we have. But then we have to go further into applications and customers to see how that materializes. I can't give you more information right now other than that it looks like an attractive market for us and our products.
Fair enough. I think you added some there. And then, generally, on the group level, you achieved your 20% target, 24% in the quarter. From your like -- when you look at your backlog going into this year, is it reasonable to assume that you will reach 25%? Or is that a too conservative number for you guys?
Yes. We don't guide on the exact number, but we have a strategic plan that basically says by the year '28, which is the last year of our strategic 5-year plan, we want to be at 30%. So there will be steps in between from basically 20% to 30%, yes. But we don't guide on where we want to be each year because the growth is likely to be exponential rather than linear.
Fair enough. To me it seems like you're running a little bit ahead of your target here. Maybe a more housekeeping question on -- in the quarter if we look at your price compensation and material cost, can you maybe talk about how you were there? And looking at this year, what type of a spillover price should we assume? And also if you put that into perspective, is it like material costs coming down somewhat, but also wages being up?
Yes, I think when we look in general, as Marcus has said before, our direct material and labor from sales are pretty consistent over the past 2 years, which basically means that all cost increases have been successfully passed on to our customers. We are seeing a bit of labor inflation, obviously, going into '24, which is a carryover from the general inflation we have seen in '23. But in '24, as it -- a few exceptions might be there, but in general we feel that the material inflation has basically come down. We don't see a lot of price increases there. So -- and the labor inflation actually will be passed on or compensated through efficiency actions. So we don't think that '24 will be a year where we have to have a high level of pricing activities simply because the underlying cost base is more likely to be stable.
Fair enough. And just maybe a detailed question on that. In terms of your price compensation, has that been retroactive? Or have you been managing -- just like you're raising the prices on the component to the supplier? Because sometimes the OEMs just want the suppliers to present these increasing costs year-on-year, and then he compensates for that in like one chunk. And that is typically lagging. So how is it for you guys?
Yes, there isn't a one-size-fits-all answer to that question. So in general, when you look at our numbers, we have been passing on cost increases to customers. There are always a bit of a lag. Basically, it might take you a quarter or so. In some cases, you might also get a retroactive price increase. But it really depends on customer by customer. There isn't one answer to all customers.
And to give you a level of materiality, the majority of our price increases are passed through on part through to end customer. And the more rare is for us to get a retro back on to it. So I don't want you to think that there's influence within large retros that are coming in skewing the margins. We get the odd bit, but it's not material overall for the group.
There are no further questions on the phone. I would like to hand back over to the speakers.
Okay. Thank you very much. So I think we covered all the questions here in the room on the phone. If there are no further questions, I'd like to thank all of you for both your participation as well as the good questions and the high level of interest in Concentric performance and strategy. And I would like to close off the session. And thank you very much and see you soon. Have a good day.
Thanks all. Bye-bye.
Bye.
This concludes today's conference call. Thank you for participating. You may now disconnect.