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Edited Transcript of GRNG.ST earnings conference call or presentation 24-Oct-19 8:00am GMT

Q3 2019 Granges AB Earnings Call

STOCKHOLM Oct 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Granges AB earnings conference call or presentation Thursday, October 24, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Johan Menckel

Gränges AB (publ) - CEO

* Oskar Hellström

Gränges AB (publ) - Deputy CEO & CFO

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Conference Call Participants

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* Fredrik Olsson

Handelsbanken Capital Markets AB, Research Division - Analyst

* Karl Bokvist

ABG Sundal Collier Holding ASA, Research Division - Analyst

* Mats Liss

Kepler Cheuvreux, Research Division - Equity Research Analyst

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Presentation

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Johan Menckel, Gränges AB (publ) - CEO [1]

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Welcome to Gränges Conference Call for the Third Quarter of 2019.

Here in Stockholm, it's me, Johan Menckel, CEO of Gränges; and beside me, I have CFO, Oskar Hellström.

As usual, we will start this presentation with an update of Gränges' performance during the last quarter and touch upon some important events. After that, Oskar will take you through the financial results, and then we will conclude the presentation with a short summary and the Q&A session.

Starting with the third quarter of 2019 highlights. One of the main themes of the quarter is undoubtedly the challenging market conditions, especially on the automotive side of our business. Demand in Asia and, in particular, China remains to be on the weak side, but we did also see lower demand from European automotive customers in the quarter. The demand for the HVAC and other businesses in Americas continues to develop positively, but we are, unfortunately, not able to capture this growth due to limitations of available production capacity.

In addition, we experienced production disturbances in 2 of our U.S. plants in the quarter, which limited the production output and sales volume further. As a consequence of the lower market demand and the production disturbances, our sales volume declined by 8% year-over-year in the third quarter. Due to lower sales volume and additional cost related to the ongoing expansion projects, the adjusted operating profit declined to SEK 190 million in the quarter. Higher prices in Americas and favorable foreign exchange rates had a positive impact on the earnings.

Further, on the positive side, the cash generation continued to be very strong in the quarter. The adjusted cash flow before financing amounted to SEK 442 million. We currently have a very large focus on completing the U.S. expansion projects in Huntingdon and Newport. We reached a very important milestone in the third quarter when the first coil was rolled in the new rolling mill in Huntingdon. This means that all the production equipment is now operational, and that we will be able to ramp up production volumes over the coming quarters.

During the third quarter, we experienced soft -- continued soft market conditions for the automotive part of our business. If you look at some market statistics, the research from IHS has made a quite substantial revision of the estimates since we presented our outlook for quarter 3 in July.

At the time, IHS estimated a 2% global growth for the third quarter, and that figure has now changed to a 3% decline. This is also more in line with the signals that we are picking up in the market. If you look at estimates by region, we can see that the production of light vehicle was down 5% in Asia in the third quarter. Of this, China was down 7% compared with last year. On top of the reduction in vehicle build rates, destocking of inventory in the supply chain continued to have some negative impact on demand for our products.

For quarter 4, IHS expect a similar development in Asia as for quarter 3 when it comes to light vehicle production. We do, however, see some signals indicating that customers' inventory levels have come down in Asia and that destocking in the value chain is leveling out. This would mean a slightly more positive outlook for Gränges for the fourth quarter compared to what is indicated by the Asian car production figure.

In Europe, light vehicle production is estimated to be flat to slightly negative compared with last year in the third quarter. The destocking in the value chain that we started to see in Europe in the second quarter has increased in the third quarter. And with the light vehicle production decline indicated for the fourth quarter, we expect this to continue for the rest of this year.

The Americas market continues to hold up better, with an estimated increase in car production of 2% in the third quarter. For the fourth quarter, the Americas light vehicle production figures are expected to be revised down due to the General Motors' strike that will impact production in the U.S., at least in the month of October.

For the fourth quarter, IHS estimates a decline of 3% in light vehicle production on a global level. Based on what we are picking up in the market, we currently have a slightly more pessimistic view on the quarter 4 outlook for the automotive business.

If you then look at Americas HVAC market, which represent 1/4 of our sales, we can see that the HVAC unit build in the U.S. is expected to have an increase by about 3% in the third quarter. Looking ahead, HVAC unit build forecast continue to show a positive growth expectations in the coming quarters. At the same time, the uncertainty about the general U.S. economy is increasing. This has led that some of our customers have indicated that would like to reduce the inventory levels towards year-end. As a consequence of this, we expect to see lower demand year-over-year for HVAC in the fourth quarter.

As I mentioned earlier, we experienced temporary production disturbances in the U.S. in the third quarter. The disturbances affected the Huntingdon and Salisbury plants in July and August. As of September, we are back to normal operations in both locations. Although the experienced issues were relatively minor, they impacted plants that are running at maximum capacity utilization. Because of this, there is no flexibility in the plants to make up for lost production capacity and all reduction in capacity is directly translated to sales volume. In total, the production disturbances had a negative impact on sales volume with 6,000 tonnes in the third quarter.

During the quarter, we have strengthened the production organization in Gränges Americas to further increase the focus on process stability and availability of the production assets. Moreover, the start of production for our expansion investments will ease the current capacity constraint and create more flexibility to handle this type of temporary disturbances.

If we then look into Gränges sales volume development, during the third quarter, we can clearly see the impact of a softer automotive demand and the production disturbances. The sales volume in Asia decreased by 15%. The reduction reflects the lower vehicle production rate and the destocking at many of our customers, in particular, China.

On the positive side, sales to industrial applications continued to increase, but from low levels. In Europe, sales volume decreased by 7% in the third quarter due to the weak underlying market demand and increased destocking at our customers.

In America, sales volume was 6% lower than last year. This includes a growth of 8% for the automotive business and a decline of 8% for the HVAC & Other business. The vast majority of the decline is driven by the temporary production disturbances. With a normal production level, we would have recorded a sales volume growth of about 4% in Americas in the third quarter.

As you know, we are getting closer to finalizing our U.S. expansion projects, and we reached a very important milestone during the third quarter when the first coil was successfully rolled in the new rolling mill in Huntingdon. This means that all new equipment in Huntingdon is now operational. Over the coming weeks, further adjustment will be made to the rolling mill. And after that, we will start to gradually ramp up the production capacity.

The Huntingdon expansion will add new capacity for growth. We expect a gradual ramp up of the 40,000 tonnes additional capacity in Huntingdon over the coming quarters. Our target is to have 75% of the capacity available by half year with a full capacity being reached before year-end 2020.

We have not contracted the full capacity increase for 2020 to allow for some flexibility during the ramp up phase. Per October, the sum of all contracted volume for HVAC and other market segments for 2020 is 10% higher than the expected volume for 2019. This is expected to increase slightly as more contracts will be finalized over the coming weeks. The actual outcome will be depend on the market demand.

In Newport, the work with upgrading the rolling mills is progressing to plan, and we expect to have a second rolling mill completed during the fourth quarter. When that is completed, we will begin with customer trials and product validations. Net start-up cost for the 2 projects amount to SEK 22 million in the third quarter. In the fourth quarter, we expect to carry additional start-up cost of about SEK 10 million.

I'm very satisfied that we have reached this far with the expansion project. Our Americas team has done a very good job in managing these, at the same time as operating the daily business at a very high level.

With that, I hand over to Oskar for the financials.

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [2]

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Thank you, Johan. As Johan has talked about, the sales volume continued to decline in the third quarter. As a consequence of this, we also saw the adjusted operating profit come down somewhat in the quarter and the rolling 12-month profit per tonne declined to SEK 2,600.

For the automotive business, the lower sales volume has led to a lower margin, but this is partly offset by improved margins for the HVAC business where we had a profit per tonne increase despite the lower sales volume. Key drivers for this are the mix optimization and price increases in the U.S.

If we look at the third quarter financials and compare with the same quarter last year, we can see that the volume decreased by 8.1% to 85,800 tonnes, whereas the net sales decreased by 9.7% to SEK 3 billion. The main reason for the net sales decreasing more than the sales volume is lower metal prices than last year. The net impact from foreign exchange rates was positive SEK 208 million compared with third quarter 2018.

Looking at the earnings. The adjusted operating profit amounted to SEK 190 million in Q3, a decrease of SEK 40 million or 17.7% on prior year. The negative impact from lower sales volume and a slightly higher operating cost was partly offset by higher average conversion price and net changes in foreign exchange rates that was positive by SEK 24 million in the quarter. The temporary production disturbances in the U.S. primarily resulted in lower sales volume. Additional maintenance and transportation costs due to the disturbances was about SEK 5 million in total in the quarter.

As you heard from Johan, we are getting closer to the completion of the expansion projects in the U.S., and the net start-up costs for these amounted to SEK 22 million in the third quarter. Looking at the profit margin, the adjusted operating profit per tonne declined from SEK 2,500 to SEK 2,200 in the quarter. There are no items affecting comparability in the third quarter, and the reported operating profit is, therefore, the same as the adjusted operating profit in the quarter.

The profit for the period increased by 26% to SEK 198 million and corresponds to earnings per share of SEK 2.62. The reason for the increase in profit is that we, during the third quarter, received approval for the high-technology enterprise tax status in China, both final approval for year 2018 as well as a pre-approval for the period 2019 to '21. As a consequence of this, we get a combined positive tax effect of SEK 77 million in the quarter. With the high-tech status approved, we expect the combined tax rate for the group to be about 18% in 2019 and some 19% to 20% in 2020. By the end of September, the return on capital employed was 12.8% on a rolling 12-month basis.

During the third quarter, net debt remained stable at SEK 3.6 billion, but increased to 2.7x adjusted EBITDA on a rolling 12-month basis. We continued to see a very strong underlying cash generation in the quarter where the cash flow before financing adjusted for expansion investments amounted to SEK 442 million, including a working capital release of SEK 259 million. This corresponds to an operating profit to cash conversion of 233%. We also continued to invest in total SEK 287 million in our expansion programs. Of this, SEK 245 million are related to U.S. and SEK 42 million to Sweden.

After the expansion investments in the U.S. will be completed, the positive EBITDA generation from these, in combination with Gränges' overall strong cash generation, is expected to start to bring down the leverage ratio back down towards the target range of between 1x to 2x adjusted EBITDA.

Over the last couple of years, we have made substantial efficiency improvements in Gränges that have made the business more resilient and the ability to handle changes in the market demand has been improved. As we talked about in our Q2 presentation, we have launched additional cost efficiency measures to adjust the cost base to the lower sales volume. Based on the outlook for the fourth quarter, which is the seasonally weakest quarter of the year for Gränges, we have complemented the earlier implemented general savings program with capacity adjustments. This means that we will temporarily shut down some of our production equipment in the fourth quarter and that we will stop some of the plants for longer than usual over Christmas and New Year's. The target with these actions is to convert as much as possible of the semi-variable cost into variable cost, and then make sure that it can be adjusted down in relation to sales volume.

In addition to the short-term measures that will have an impact on the fourth quarter, we've also decided to increase the efficiency in our European white-collar organization. In total, this organization will be reduced a little bit more than 20 positions or about 14%. This is expected to have a positive impact on operating cost from 2020 and onwards. The onetime cost for this of SEK 15 million will be recorded as an item affecting comparability in the fourth quarter this year.

With that, I hand over back to Johan Menckel, who will provide the outlook for the fourth quarter.

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Johan Menckel, Gränges AB (publ) - CEO [3]

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Thank you, Oskar. Looking into the fourth quarter of this year, we expect that the challenging market conditions will continue. In terms of year-over-year sales volume development, we expect to see a mid- to high single-digit decrease on group level in quarter 4.

For automotive materials, we foresee a mid- to high single-digit sales volume decrease globally. In Asia, we expect a stable sales volume compared with last year, partly due to weak comparables, but also due to that customers' destocking seems to level out.

For Europe, we expect a low double-digit decline as the light vehicle production is expected to remain weak and customers' destocking to increase towards year-end.

In Americas, we foresee a low double-digit decline for the automotive business, partly as a consequence of the General Motors' strike. For the HVAC & Other part of our business in Americas, we expect a mid- to high single-digit decrease in the fourth quarter due to increased uncertainty in the U.S. economy and indications from some customers that they intend to reduce their inventory levels towards year-end.

While looking further ahead, we will continue to work actively with innovation, efficiency improvements as well as some more sustainable customer offerings, which includes an increased focus on product development for electrical vehicles. With a strong commitment to constantly improve and develop, Gränges is well positioned to continue to deliver sustainable and profitable growth.

To conclude the 2019 third quarter report, we continue to see soft market conditions in the third quarter. And together with temporary production disturbances in the U.S., this led to that we experienced an 8% decline in sales volume compared with last year. The adjusted operating profit was reduced to SEK 190 million, but the cash generations remained strong with an adjusted cash flow before financing of SEK 442 million.

Our expansion projects in the U.S. are moving forward, and we reached an important milestone in the third quarter with the first coil rolled in the new Huntingdon mill. Although the market conditions are expected to remain soft in the coming quarter, we continue to be positive about the medium-term outlook and are determined to continue to grow and strengthen our presence and positions globally.

Now we open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Mats Liss from Kepler Cheuvreux.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [2]

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Well, just coming back to the development in the U.S. there, and you mentioned that you gradually sort of start to increase capacity in the investments you have made. And I just was wondering, on the other side, you see a somewhat soft market conditions going forward in the next couple of quarters. How will that sort of affect pricing you could, well, expect to see from this additional capacity?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [3]

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Yes. Mats, it's Oskar here. I think it's a fair question. I mean we do see, as Johan has indicated, a softer -- softening of the outlook of the market here, especially in the fourth quarter. In terms of pricing, we are working with long-term contracts. Some of these contracts are up for negotiation this year. Some of them has been closed earlier. In terms of pricing guidance for next year, you should think about that as -- for 50% of the volume, we are looking at price increases of some 4% to 5%.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [4]

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Yes. Great. And well, regarding the additional capacity now, do you expect to -- well, see -- well, customers sort of signing up for contracts? Or do you expect to sell it in the spot market? Or how -- well, could you do something there?

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Johan Menckel, Gränges AB (publ) - CEO [5]

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Yes. Johan here. Of course, I mean we have contracted a 10% increase in volume in 2020 compared to 2019 for North America. And we have, of course, still flexibility to contract more volumes, which we expect to do during next year. And this is actually an increase. So we are, I mean, gaining market shares in the North American market for next year. And that's also why we are optimistic that we will be able to gradually fill the new capacity that we will come out to the market for next year.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [6]

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And finally, just about -- well, you mentioned the fourth quarter -- now that we've closed down production to handle, well, inventories and so on, should we expect a larger -- I mean the fourth quarter is still the weakest earnings, well, seasonality. And how much sort of extra should we expect there this quarter?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [7]

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You mean extra of what, Mats? Extra cost savings?

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [8]

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No. I mean we have a seasonality historically, which is -- the fourth quarter is the slowest of the year. But what the -- I mean you indicate -- yes.

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [9]

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Yes. I think you should think about the volume development in the fourth quarter this year, as Johan guided for earlier here, that we see a combined decline of the group versus fourth quarter last year in terms of sales volume then for mid- to high single digits. So it's a seasonally weakest quarter, but it will also be slightly weaker than fourth quarter last year is what we foresee at this point.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [10]

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But production with around at the lower level than that, I guess?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [11]

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Yes. We will close down some of our production plants for longer than usual over Christmas and New Years to sort of take out capacity, take out some of the variable cost as well then to manage profitability in Q4.

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Johan Menckel, Gränges AB (publ) - CEO [12]

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Yes. To add to this, Mats, Johan here. Of course, I mean the new capacity that we will have now gradually ramping up in Huntingdon will, of course, be used as much as possible. So the close or longer vacation time will more -- would be effective for the Newport and the Salisbury plant. And also on top of that, the Huntingdon plant we now have, which is actually a very modern and efficient plant in that kind compared to the other peers in U.S. for the segments that we are serving, I think that's important to have in mind as well.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [13]

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Good. And I guess the cash flow will look pretty good then if you sort of reduce inventories.

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [14]

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Yes. We, of course, always strive to reduce working capital in relation to sales volume. If sales volume is coming down, which it sequentially always do between third and fourth quarter, you would see that as in working capital, absolutely.

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Operator [15]

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Our next question comes from the line of Fredrik Olsson from Handelsbanken.

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Fredrik Olsson, Handelsbanken Capital Markets AB, Research Division - Analyst [16]

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This is Fredrik Olsson from Handelsbanken. I have a question on CapEx. You said SEK 409 million in the quarter, of which SEK 287 million relates to the expansion. I didn't hear you. But could you repeat the split on U.S.-Sweden there? And maybe develop further on how this is going to look going forward into the fourth quarter and then 2020, please?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [17]

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Yes, absolutely, Fred. The SEK 287 million then of that expansion part of the CapEx, and SEK 245 million of those are related to U.S., and SEK 42 million of those are related to Sweden.

If we look a little bit further ahead, of course, we will push for finalization of the U.S. projects here now in Q4. So we expect to spend about an additional SEK 100 million of expansion CapEx in U.S. in Q4. And then there will be some minor overspill of that into 2020.

In terms of CapEx guidance then for 2020, it will largely be the base CapEx, the maintenance CapEx as we see them for 2020. And our guidance there is that around 80% of depreciation is what we are sort of typically spending on maintenance. That means about SEK 400 million next year. In addition to this, we have the Finspång expansion or logistics projects ongoing. Therefore, we foresee some SEK 200 million or so next year. And then you have some smaller part of CapEx left for the U.S. projects, as I mentioned.

So this will add up to some SEK 600 million to SEK 650 million CapEx expected for 2020.

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Operator [18]

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(Operator Instructions) And our next question comes from the line of Karl Bokvist from ABG Sundal Collier.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [19]

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I apologize, my line was a bit blurry when you talked about the contracted volumes here. So if you could provide some more details on that, you said a 10% increase in contracted volumes versus 2019 level. Should one roughly interpret this that you expect, perhaps, that the Americas volumes could increase by 10% for next year? How should one think about actual volumes?

And then when you said the capacity ramp up, you expect 75% by the end of H1. So I'm just curious, how do you expect to see this phasing out in Q1 and Q2?

And finally, I apologize then. You previously had a target to recoup your production investments during the second half of this year. I was just wondering, how should one expect this earnings to come in 2020?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [20]

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Yes. Karl, very good questions. This is Oskar here. First then, regarding the contracted volume, you're absolutely right that right now, we have a contracted volume base for North America then for next year, which is about 10% higher already than the actual volume expectation for 2019, and we are now in the period when you close many of the contracts for next year. So we expect this to increase somewhat in the coming weeks as well.

But what it means, of course, is that we have contracted in a larger market share for next year than what we had this year. And of course, that leads us to believe that there is a fair chance of seeing a higher volume in the U.S. in the month and -- to come here. What this ultimately will be, of course, depends on the ultimate market demand, but our market share of that demand will be higher next year. That was the answer to your first question, I hope.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [21]

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Yes, it was.

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [22]

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And then your next question was about capacity ramp up for next year. Yes, we've indicated that the target is to have 75% of the 40,000 Huntingdon tonnes ready by the end of the first half, full capacity ready by the end of the year. The way this works, of course, is that, basically, when you turn the key to the rolling mill, you will get some capacity there already upfront. And you pick the low-hanging fruits when you tune the mill, which means that quite a large part of the open -- capacity will open up earlier. And then it's a hard work, of course, to fine tune it and get the last part of the capacity available.

So if you think about timing over quarters, you could think that a large part of the capacity will come in the first quarter, a little bit less incremental capacity then in the second quarter. Those would add up to 75%. And then, again, a little bit less in the third quarter and an even smaller part in the fourth quarter, and then you're up to 100% before the end of the year.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [23]

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Okay. So a bit front-loaded then one could assume?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [24]

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That's how it will work from a sort of a technical perspective here.

And then your final question was on the guidance here for the full year. Yes, you're absolutely right. We planned originally to recoup some of the sort of start-up costs already this year. And with the volume outlook that we now see for Q4, we need to remember that the new contracted volume, that's valid for 2020 and onwards, so sort of any additional capacity available this year will need to be sold on spot. And given the sort of softer market outlook for the Q4 that Johan has indicated, it's not unlikely that we will sell additional volume on spot, but we will get sort of cost efficiency impacts, of course, from the new investments because the new rolling mill is more efficient than some of the existing capacity.

But as we indicated earlier, the net start-up costs for Q4 is expected to be around SEK 10 million, which means that we will see sort of the positive impact on the earnings from the investment that will come in 2020 and onwards.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [25]

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Yes. All right. And then just a small add-on to the question here. I mean do you see any sort of indication from customers that they are becoming a bit more uncertain then that they in turn are reluctant to sign up for more volumes?

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Johan Menckel, Gränges AB (publ) - CEO [26]

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Johan here. If you refer to North America, we, of course, in the short term next quarter, we see a more uncertainty on the demand there driven by that has been some inventory buildup due to trade wars and of course, the economy in general leads to maybe a hesitation from customers to replace the HVAC units. But we haven't seen any sign for next year of a reduction in volume. And you should also bear in mind that the house building rates in the U.S. will go up, and yes, actually it's increasing and around 20% of our HVAC demand is driven from the house building rate. So of course, going forward, there will be a need for new heat exchanger in houses in the U.S. So I think that's what you see in the more medium to long term.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [27]

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Okay. And sorry for asking a lot of questions here, but just 2 quick ones here. So when it comes to the tax effect, it was positive this quarter. And then you said one could expect the tax rate effectively for next year around 19% to 20%. I was just wondering, is there a specific quarter where you will see a positive effect? Or will it be sort of evenly spread out?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [28]

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Yes. We only provide sort of a full year figure for the tax guidance. The tax rate might vary from quarter-to-quarter. It typically does. So you should view the guidance there as the full year guidance. But it's fair to assume that guidance also on a quarterly level, I would say.

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Operator [29]

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(Operator Instructions) And we have another question registered from Karl Bokvist from ABG Sundal Collier.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [30]

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Yes. I was just curious. Perhaps, if you could -- if we weigh it all together for the coming quarters and into 2020, what's your -- if you could provide us the expectations for EBIT per tonne. Because I think, previously if we assume that you will be able to recoup some of your start-up costs in 2020, and then you have some price. What's your view on profitability per tonne going forward?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [31]

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It is, of course, a very good question there Karl. We don't typically provide guidance on anything else than volume. But that said, we have, of course, a lot of good initiatives in place in Gränges addressing our cost base. That would, of course, give a positive impact on the EBIT per tonne going forward.

That said, I think the most important driver for this in the next couple of quarters will be the volume development, and that's going to come down very much to the end market demand, and that's very difficult for us to have a view on at this point, given the quite large uncertainty in the world, I would say.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [32]

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And just out of curiosity, do you have any updates on the TRILLIUM products and the commerciability and so on?

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Johan Menckel, Gränges AB (publ) - CEO [33]

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Yes. Johan here. No, there's actually a lot of activities on the TRILLIUM, and it's clearly so that -- for the car producer, the OEMs, it's extremely important to have a very low level of flux in their battery cooling system because the flux will contaminate the battery. So there's a large interest, both on the OEMs and also from our customers. So we are, right now, having a lot of tests and validations with several customers. And we've been also validated to -- at one plant at one of our large customers with the TRILLIUM product. And that means, of course, in the longer run, that we will also be able to open up for more of their plants globally, which is a very good news for Gränges.

But this clearly shows that TRILLIUM addresses a lot of the concern with the battery cooling and the flux residue. So we are optimistic about the TRILLIUM future.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [34]

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And then just -- I think previously, you said something about how much of volumes you expect TRILLIUM to be in 3 or 5 years. Could you just provide an update on this?

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Johan Menckel, Gränges AB (publ) - CEO [35]

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It's a difficult question. I can't recall what I said. But I think we said that, of course, over time, there is -- for the traditional business we have, of course, I mean, 10% or 15% could be based on TRILLIUM. But also, I think what we also see that we can offer TRILLIUM into new applications where we are not today. So of course, that is more difficult to evaluate the potential for the new business. But that's at least give you some figure.

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Operator [36]

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We also have another question from the line of Mats Liss from Kepler Cheuvreux.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [37]

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Just coming back to the slowdown in China and the lower volumes to be expected there. And I just wonder if you -- well, you keep the market positioning you have sort of or do you see increased competition from domestic supplies or more, I mean, Chinese company?

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Johan Menckel, Gränges AB (publ) - CEO [38]

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No -- a good question. Johan. No, we still see that we are maintaining our market shares in Asia and in China. The competition we have experienced in China has been quite similar for many quarters now in Gränges. And yes, having said that, of course, and also in terms of market, as we said, we see a -- still a softening market in the quarter 4. But there are some signs, of course, on the commercial side for heavy truck that, that will increase due to the restriction on weight loading in China. Now there's been several serious accidents related to overloaded trucks, which is, of course, will drive at least the heavy vehicle sales going forward, which can be a little bit of positive, even though that's a smaller part of the total market.

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [39]

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Okay. And just sort of -- well, the -- you should (inaudible) previous question here about the hot roll capacity there. I mean you have plans to do something long term, but if it's something (inaudible) sort of held back by the current market conditions? Or do you see opportunities in this area?

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Johan Menckel, Gränges AB (publ) - CEO [40]

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I think in the medium to long term, Mats, we are, of course, positive to Asia. And China, in particular, there's still a very low level of penetration here and the growth prediction is high. So we are, of course, right now, we have available capacity to address the future need. But we are, of course, always looking for good business opportunity in Asia since it's an important market for Gränges.

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [41]

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Just to verify, Mats. The line was a little bit unclear. Did you ask about U.S. now? Or...

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [42]

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Yes, the U.S. Sorry.

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [43]

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So hot roll capacity in U.S. was your question, I think?

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Mats Liss, Kepler Cheuvreux, Research Division - Equity Research Analyst [44]

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Yes, that's right. So I mean it's a standard question. And I guess the question was more related to if the current market conditions there are holding you back there? Or I mean -- yes.

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Johan Menckel, Gränges AB (publ) - CEO [45]

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No. Okay. Good question. Sorry, I misunderstood. No, we, of course, looking for that opportunity. But right now, we have a good logistics setup where we can serve part of the demand from our U.S. plant and part of the demand from Sweden where we have available capacities. So we -- in the short term, we don't see immediate need to address the hot rolling capacity in North America.

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Operator [46]

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And there is another follow-up question from the line of Karl Bokvist from ABG Sundal Collier.

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Karl Bokvist, ABG Sundal Collier Holding ASA, Research Division - Analyst [47]

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Yes. I was just wondering, from your experience, how long do you think that inventory adjustments in the HVAC market could persist if you compare to inventory adjustments and destockings within the automotive industry? And what I'm after here is really, how long do you think these effects could persist in the market?

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Oskar Hellström, Gränges AB (publ) - Deputy CEO & CFO [48]

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I think, Karl, it's a very fair question. The answer to that is probably, it depends very much on what will happen with the market demand, the end market demand going forward. But to sort of add to that, what we see in the -- on the HVAC side, to give you a little bit more flavor, is that what happened in the U.S. HVAC market is that when the U.S. administration introduced these anti-dumping duties to China, a lot of the customers here had to find additional sourcing. There are, as you probably know, not so many rolling mills domestically in the U.S. that serves this. We are, of course, one of them, but we are running at maximum capacity.

They had to source their material from elsewhere, not from the U.S., but also no longer from China. So they basically went around the world, trying to find additional material. A lot of these customers built up safety inventory to make sure that they would manage a situation where they couldn't basically access raw material for their product, which means that the inventory level at the customers are relatively high now, also sort of in historical measures. That, combined with some weakening signs of the general economy in the U.S., has sort of led to a situation where there will be a lot of inventory reductions in quarter 4 to get to sort of a more normal inventory level before year-end. This is what has been indicated to us.

No one, so far, has sort of said anything about further inventory reductions in the next year and so forth. So if that will come or not, it will depend very much on end market demand, I would say. At this point, it's a lot about taking safety stock down.

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Operator [49]

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Thank you. And if there are no more further questions, I will now hand back to our speakers for any closing comments.

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Johan Menckel, Gränges AB (publ) - CEO [50]

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Okay. Thank you. I would like to thank everyone for participating today on this conference call. As usual, we received good and interesting questions. I hope we have been able to answer them. We look forward to our next call on January 30, 2020, when we present our full year report for 2019.

Thank you, and goodbye, everyone.